AGNC Investment Corp. (NASDAQ:AGNC) Credit Suisse 24th Annual Financial Services Forum February 14, 2023 3:15 PM ET
Company Participants
Peter Federico – CEO
Sean Reid – EVP, Strategy & Corporate Development
Conference Call Participants
Douglas Harter – Credit Suisse
Douglas Harter
Thanks for joining us. I’m Douglas Harter from Credit Suisse, cover mortgage finance, including the mortgage REITs and happy to have AGNC back at the conference with us. Up here on stage with me, we have Peter Federico, CEO; and also from AGNC, we have Sean Reid in the audience.
So first, Peter, thanks for joining us.
Peter Federico
Thank you for having us.
Question-and-Answer Session
Q – Douglas Harter
Just to start, can you just help put into context where Agency MBS spreads are today versus kind of long-term averages?
Peter Federico
Yes. I mean, we have a really positive outlook for Agency MBS spreads. And we know how wide and cheap Agency MBS spreads got in the fall of last year to really unsustainable levels. They have tightened quite a bit from the wides. I always like to look at, for example, current coupon spreads to 10-year treasuries just as a good benchmark. If you look at that over historical time periods, gives you a good view of where spreads are.
They got as wide as close to 200 basis points, which we thought was unsustainable, but consistent with the really unstable environment that we had in September. Since that time, spreads have tightened fairly significantly. Those spreads today are at about 150 basis points off the 10-year. If you looked at a combination of current coupon spreads to the five-year point on the curve or 10-year point on the curve, you’re still looking at about 140 basis points.
To put that in historical context, if you look back over the last, say, 14 or 15 years, that spread to the 10-year, the current coupon to the 10-year has averaged around 80 basis points. So, we’re still really wide by historical standards. We think they’re going to stay wider than historical standards. We could talk about more later, but when you think about spreads where they are today, well off the wides, but still really attractive relative to historical. And that’s really given us a great opportunity to generate attractive returns in Agency MBS.
Douglas Harter
And I guess if you were to look at OAS spreads, that’s probably a slightly different answer there. So I mean, I guess, just help with that in context and then how do you think about which is more important as you’re kind of driving returns at AGNC?
Peter Federico
Well, our business is more of a spread business. So I tend to look at the nominal spreads as more indicative of sort of the earnings power on a levered portfolio, but there can be information as well in OAS. But the challenge that you have with an option-adjusted spread, if you think about what that spread is telling you is, if you perfectly hedged out all of the optionality or convexity costs, which there is impossible to do.
But if you did that, that would be sort of the residual that you would have left for model risk or prepayment variability. That spread can be informative, but it also is impacted by the cost of interest rate options, right? Implied volatility goes up or down, then that option-adjusted spread goes to the opposite direction. So if interest rate volatility is going up, which is bad for a mortgage position, if you’re looking just at option-adjusted spreads, it’s going to actually sort of give you a misleading picture because option-adjusted spread tighten in that environment.
So, I always think about it as those two spreads are the bookends for mortgage, what would that spread be if it was perfectly hedged out would be the option adjusted. If you didn’t hedge any of it out, it would be the nominal spread. And for us, the answer typically is somewhere in between because over time, we are going to hedge some of that cost out. We don’t hedge it all out upfront like an option adjusted spread would sort of tell you. We will do most of that over time as we rebalance the portfolio.
So, I think you always have to look at both, we’ll tell you something about the richness or cheapness OAS can be a really, really valuable tool when you’re looking at the relative value of two mortgages, for example, and it’s informative in that way. But really, when you look at spreads over the long run, I think if you look at the nominal one, it gives you an easy picture and it sort of tells you the direction of richness and cheapness, which I think most investors can understand better.
Douglas Harter
You touched on this a little bit. But just can you talk about how kind of the impact of the yield curve affects which point of the curve you’re looking at for the — that nominal spread and how that might inform some of the answer?
Peter Federico
Yes. Well, often, when people think about our business model as a levered investor, usually, the question is, if an inverted yield curve is it really bad for your business, can you make any money? And the answer always is, it’s what spread mortgages are to the particular point on the curve. So because when we’re looking at, for example, the most inverted part of the curve, today, it’s almost 85 basis points, two years to 10 years, it’s inverted as it’s really ever been. And it won’t stay that inverted.
But really, the question is where are mortgages to that point on the curve. So if we were to buy a new mortgage today and hedge it predominantly with the 10-year point on the curve or a five- and 10-year point on the curve, you’re still looking at really attractive returns, despite the inversion of the curve. From a hedge perspective, we typically hedge across the curve. So we’re always going to use a combination of shorter-term hedges, intermediate-term hedges and longer-term hedges.
When you think about mortgage, richness or cheapness in the spread, it’s typically from a duration perspective that would be the right spot on the curve to look at as of what spread you can generate. So over time, the curve will not stay this inverted because the curve is inverted, it is actually costly to maintain a positive duration gap, which most REITs do. So, there’s some incremental costs that we are incurring in this environment because of the inversion. But again, I don’t believe it’s going to be sustained. And ultimately, mortgages are cheap to the longer part of the curve.
Douglas Harter
Got it. You mentioned that you think sort of spreads stay wide of kind of the long-term averages. Can you just talk about kind of why you think that is?
Peter Federico
When you think about the mortgage market, where we were and where we’re going, I think you see two very different landscapes. And I think we just sort of observed this transition and how volatile it was. If you look back over the last, say, 15 years, remarkably, the Fed has been an active participant in our Agency MBS market in like 11 out of the 15 years, 11 out of the 14 years, which is probably higher than most people realize because they did QE1, 2 and 4 in Agency MBS, but they also maintain the reinvestment program for a significant part of that time.
So if you think back, we have been competing with the most uneconomic buyer of mortgages for most of the last 15 years. And that spread on average, as I said, was about 80 basis points. When we look forward, if the Fed is — take the Fed word and say they are going to gradually exit the Agency MBS business, the next 10 years, we won’t have to compete with that most uneconomic buyer.
But for that reason, you would also expect spreads to settle out at a wider level. When you think about bond market liquidity in the past versus going forward, I think we all might now realize that bond market liquidity given the structural changes that have occurred post Dodd-Frank, bond market liquidity is going to be lower. Interest rate volatility is slightly higher, and the Fed is likely not going to be participating in the Agency MBS market.
The combination of those three things, I think, tells us that spreads should settle out at a wider level than they did over the next 10 years over the last 10 years. And that actually is why we’re so encouraged about our business. That’s — we actually want that to be the case. We can generate better returns for our shareholders if spreads stay wider, and I believe they will stay wider than they have historically.
Douglas Harter
I guess just on that point, spreads stay wide, you have the ability to generate those returns over time. If spreads tighten, you kind of get the near-term benefit. I guess how do you think about kind of what you’re rooting for?
Peter Federico
Well, actually, I think we’re going to get a little bit of both. So when you think about the short-term outlook, and I’d say shorter near-term outlook for spreads, I would say that if we look three months from now, six months from now, 12 months from now, I think spreads will be tighter than they are today. And I think they’re tighter than they are today because we’ve gone through the significant part of the interest rate transition and the monetary policy transition.
When you think about the supply of Agency MBS, I think it’s relatively manageable. The organic supply because the housing market is so slow and there’s affordability challenges with house prices and with mortgage rates being where they are, organic supply should be probably in the $200 billion range this year. The Fed’s portfolio is going to run off at a historically slow pace given where prepayment speeds are now, maybe $15 billion, $16 billion a month, maybe less than $200 billion for the whole year.
So the private sector is going to have to consume about $200 billion — or $400 billion worth of mortgages, which is not that dramatic, particularly against the backdrop of fixed income demand, I believe, will be greater than the market is anticipating. And I think we saw the big transition in fixed income demand. Last year, we had about $250 billion of outflows on bond funds. I think this year already, we’ve had $50 billion of inflows.
So fixed income demand, I think, will remain high given where we are in the rate cycle. Supply will be manageable. And ultimately, interest rate volatility, I think, is poised to decline, right? As the Fed is nearing its inflection point, which it clearly is, whether it’s 25 or 50 or even 75, we know that the Fed is transitioning and ultimately will pause relatively soon.
So as the Fed pauses, interest rate volatility comes down that in and of itself is positive for mortgages. The supply picture is manageable. The demand should be strong. I think the combination means mortgage spreads tighten somewhat in the near term, but as I said, ultimately settle out at a wider level than they have historically.
Douglas Harter
I guess just on the demand side, banks have kind of been a key variable in both directions over the past couple of years, kind of how do you see that piece of it playing out?
Peter Federico
Well, the banks have been big buyers of mortgages. We all know that. They were significant, particularly early last year. But then we saw the transition, and they really slowed down and actually stop buying mortgages. And the banks have done sort of a couple of things that became a challenge. One is that they bought a lot of mortgages for available for sale. And then as the interest rate environment started to shift, they started to put their mortgages in held to maturity, which protected their capital.
But the position that they had in available-for-sale mortgages ended up being a negative from a capital perspective as we went through last year with interest rates rising, they suffered capital losses, if you will, from their mark-to-market from their — on their available-for-sale portfolio. And that really dampened the demand. I think that’s also potentially at an inflection point where — given where rates are the high level of rates, the potential direction of long-term interest rates, bank demand could be a surprise to the positive going forward this year.
We haven’t seen that yet, but it’s a combination of the rate environment, plus their outlook for the economy and their ability for loan growth. I’m not sure how all that plays out, but bank demand may be a bigger surprise on the positive side than people anticipate.
Douglas Harter
And then just thinking about the economic uncertainty, obviously, Agency MBS doesn’t carry credit risk. But how does potential weakness in the economy? How does that play into the supply-demand picture and kind of how spreads might perform?
Peter Federico
Well, I think one of the things that changed the momentum in the Agency MBS market was essentially partly that credit outlook that we — that you’re just mentioning. When you go back to September and October in particular, when the absolute yield on, for example, current coupon MBS was at around 6% at 200 basis points higher than the treasury for the same credit. I think that equation was what attracted unlevered investors into the Agency MBS market.
The rotation out of credit into this asset that was giving you 200 basis points off the treasury rate for the same risk with just some prepayment variability made it really attractive for both unlevered investors and levered investors. And I think the unlevered investor community remains strong today for Agency MBS. So, to the extent that the credit outlook weakens, I think that will be positive for spreads in Agency MBS.
Douglas Harter
Got it. I guess as you look at the outlook for spreads, like what would be the concerns that could maybe cause them to widen?
Peter Federico
Well, I think it’s macro. I think it’s macroeconomic and macro monetary policy uncertainty, right? Right now, the Fed has been pretty clear about what it wants to do with respect to the Fed funds rate where it wants to get another 25 or 50 basis points. They’ve been clear about that intention. The market thinks the Fed’s going to get there and then ultimately begin to ease relatively soon, as you could tell by the inversion of the yield curve.
In the markets making that call, that inflation is going to, in fact, continue to come down more in line with the Fed expectations. If we’re all wrong about that, and if inflation does prove to be materially worse than we expect or not decline or actually even increase, then the Fed may have to go well beyond that. And I don’t think that’s priced into fixed income markets generally both in treasuries or in Agency MBS.
So to the extent that the macroeconomic outlook changes, the inflation outlook changes and ultimately leads to a different outcome from the Fed that I think would be the thing that might destabilize fixed income markets to some extent, again, I do not believe, though, even in that scenario that we’ll get to the instability that we saw at the end of last year.
I think that was a confluence of macro factors that caught people off guard and led to this desire to be out of the market and be in cash, and I think that that sentiment has shifted.
Douglas Harter
I think you mentioned some about market liquidity and market structure before. But just — it seems like we’ve had more bouts of these kind of extreme volatility events. Can you just talk about how are you positioned for that? And is that something that is likely to continue kind of given lower liquidity?
Peter Federico
It’s absolutely going to continue. And this has actually been developing over multiple years, really since the great financial crisis. But the liquidity issue has been masked by the Fed’s participation in the Treasury and Agency MBS markets. As the Fed has stepped out of that market, the market participants now see more clearly that bond fund flows dominate the Treasury and Agency MBS market.
The — said another way, those two markets are dominated by passive investment. So when money managers generically get inflows, they buy Treasuries and Agency MBS. And when they get outflows, they simply sell them. And there is no longer any market intermediaries per se that take significant amounts of risk. The regulatory changes post Dodd-Frank made it much more difficult for financial institutions to intermediate risk and take risk when markets became destabilized.
Right now, those institutions are much more of agents between buyers and sellers. And I think that’s going to persist. So as long as you have a lack of risk takers in the market, which we’ll have, and as long as those flows are dominated by passive investors, then you’re going to have market times when you have really illiquid markets, and that leads to volatility. And because of that, then I think from a risk perspective, which was ultimately a question, I think all other things equal, your risk position has to take that into account and your risk position has to be dialed down somewhat to account for the fact that markets are more illiquid and more volatile.
Douglas Harter
And the other side of that is, how do you position yourself to also take advantage of that? And obviously, the challenge of managing a levered portfolio is to be able to withstand the drawdown to be able to hold on to a position or lean into a widening and kind of how do you balance those?
Peter Federico
Well, that’s always the key from a levered investment perspective is making sure that you have enough unencumbered capital in high-quality assets that allows you to withstand the adverse scenario so that you’re not forced to delever. It doesn’t mean that you’re not going to make decisions to increase your leverage or to decrease your leverage, but you want to make those decisions when you want to make those decisions on your own time.
You don’t want to — we are a permanent capital vehicle with mark-to-market liabilities. And so, we don’t want to have — be put in a position where we’re forced to delever. I’d would never want to do that. So, you’re always thinking about preserving enough unencumbered capital to make sure you can withstand the most severe scenario when it comes to both interest rates and spreads moving in a way together in a very adverse way.
And so, we always are operating from that perspective is setting our leverage level today, for example, at around 7.5x gives us $4.3 billion, for example, of unencumbered cash and MBS to help us withstand the next spread widen event or next adverse interest rate event such that we’re not forced to delever. And that’s really the key is being sure you’d be able to preserve your asset position because ultimately, spreads will tighten and widen, but they’ll come back. And if you’re able to hold on to your position, you’ll ultimately make money for your shareholders.
Douglas Harter
I guess just putting that into the real-world context, can you just kind of talk about in that context, kind of how you manage September, October, the significant weakness then fast forward through kind of January as the markets kind of came back and kind of how you managed risk, both adding and taking risk off?
Peter Federico
Well, it was the most extreme environment that market participants have ever experienced. And when you think about the speed with which the Agency MBS market deteriorated, it was worse in the great financial crisis because spreads moved so much over about an 18-month period from the spreads that we were talking about from about 30 basis points off the 10-year to 200 to 170 basis points. That was worse than we experienced in the great financial crisis.
And the great financial crisis, those spreads moved over six to eight months not over 18 months. So, it was really some pronounced periods in there of extreme moves. So when you’re in those environments, you have to prioritize your liquidity position, you have to move your position around. And we had to sell assets during that time period in order to maintain essentially the same risk profile that we had going into it.
We entered that time period with leverage at around 7x, which was low from our historical operating experience. We’re not that far off that today. And the challenge at the time, particularly in October was that we knew spreads were really wide and returns were really attractive — as attractive as they’ve ever been, but we also into markets where we’re too unstable. So we had to try to balance both wanting to be opportunistic but also wanting to be disciplined with risk management. So you have to just sort of find the right balance between those two things.
As the environment improved, it gives you more confidence to take more leverage and you just have to keep adjusting as the environment evolves. And we’re not through this uncertainty yet. It’s still an ongoing process because of what we’ve already talked about. But ultimately, I think over the next three to six months, we’ll get more interest rate clarity and that will ultimately inform us about our risk position.
Douglas Harter
Great. So, we’ve talked a lot about kind of spreads and the outlook there, but if you could just kind of translate kind of the current spreads that we have today, how that kind of translates into what type of levered returns that you see in the market?
Peter Federico
Well, there’s a couple of interesting things about the Agency MBS market. First, I would say, when you look across the coupon one of the rare times that we’ve have really 10 active coupons or something in that range, which is highly unusual for the mortgage market. I would also say that you can find value across the coupon stack, but you have to define value a little differently.
We, like many others, have moved up in coupon and have focused our buy-in on higher coupons where the production is today, call it, from 4.5% to 6.5%. And when you’re buying the higher coupons or the production coupons, you’re getting sort of the maximum yield, maximum spread because you’re taking the maximum amount of interest rate convexity exposure. And so, we like the return profile of those and we can manage that convexity risk over time.
The returns on that part of the coupon stack, if you lever them, for example, 8x given the spreads that we talked about in the or so basis point range, given our operating structure, our operating cost, you can generate mid-teens ROEs, call it, 14% to 16% ROEs. Lower down the coupon stack, the yield is materially lower. So, you’re not going to generate those sort of levered returns, but they could also be really good performing assets from a total return perspective because those coupons still dominate the mortgage index
And if the mortgage purchases are dominated by index-based buyers, money managers, they are going to gravitate to buying those coupons. The Fed owns a huge percent of those coupons and they represent a huge percent of the index. So from a total return perspective, to the extent that bond fund flows continue to come in, they may perform very well from a total return perspective. So, you have to look at them across different sort of lenses, but you can generate good value across the coupon stack.
But for the most part, we’re operating now with a greater share of higher coupons in our portfolio, but we still have a significant position in all coupons right now. And I think that, that’s a safe way to be because of the different sources of demand.
Douglas Harter
And I guess, how would you characterize the attractiveness of specified pools today where, obviously, prepay protection probably isn’t as top of mind, but versus TBAs, kind of where is the specialness on those?
Peter Federico
Well, the TBA market right now from a specialness perspective has returned rapidly to more historical standards. In environments when mortgage supply is really high, and the Fed is really active, the combination of those two things can lead to outsized funding advantages in the TBA market, and we all experienced that, and you were able to generate 50 or 100 basis points of extra return in TBAs. Today, that doesn’t exist. That spread — that differential of specialists is probably more in the 10 to 15 to 20 basis point range, which is where I would expect it to be.
Structurally, that’s about the right level of specialness. So you can still generate a little bit of extra benefit, but it’s not going to be that significant, but it doesn’t need to be because all mortgages are cheap. In pool forms, they’re cheap. So, you don’t need that extra specialness. In today’s environment, we still have a significant TBA position, but I would expect that to not change very much.
When you talk about specified pools, the pay-ups you’re correct in this environment because the mortgage universe is so out of the money. Nobody is really thinking about prepayments. Only — I think it’s 45% of the market would have a 50 basis point refinance incentive for a 300 basis point move in interest rates. So, you need a really big rally before there’s a significant refinance in that’s why the pay-ups are so low. But it’s also the time that you want to buy that protection when it’s cheap. So over time, we would likely increase our prepayment protection.
Douglas Harter
Got it. And I guess the other part of the equation would be kind of the hedging. Kind of how are you thinking about hedging in this market that’s been quite volatile? And what kind of what lessons learned have you had from kind of the past year plus?
Peter Federico
We’re always going to operate, for the most part, with a well-diversified hedge portfolio across the maturity spectrum. So call it, two years to 10 years. We also operate with a healthy mix between treasuries and swap hedges. And we do that because we think the combination of those two things, and we move that around quite a bit. What we’re trying to do is we’re trying to replicate the best market value offset to our assets. And we often find that a combination of treasury-based hedges, swap-based hedges and a mix across the curves gives us the greatest protection.
The challenge in this environment has been the shape of the yield curve and the yield curve volatility that can really have an impact on the performance of your hedges. Generally speaking, when we’re in an environment where the Fed is tightening monetary policy like they were, we operated with a really high hedge ratio over 100% because we wanted to protect our short-term funding cost against the increases in the short-term rate. And we also moved our hedges a greater share of our hedges to the short to intermediate part of the curve because we expected shorter-term rates, two-year to five-year rates, to underperform, meaning to go up the most, which they did and longer-term rates to go up less and that led to the inversion of the yield curve.
So, you wanted a greater share of shorter-term hedges. As the Fed approaches its pause point and ultimately pivots, I would expect the opposite again to occur at some point over the next few months or a few quarters or over the next year, we’ll likely operate with lower hedge ratio because the market will be expecting eases. And shorter-term rates will likely outperform they’ll likely rally. And so, we would want to move our hedges perhaps out the curve from the intermediate and short part of the curve.
Douglas Harter
Got it. And you touched on this a little bit about kind of the market expectations of the Fed kind of a couple more increases and then ultimately cutting. I guess versus the Fed kind of saying that they expect to kind of hold rates for a while, I guess, how do you ultimately expect that to play out? And how much do you actually kind of try to factor in a viewpoint into your hedging strategy?
Peter Federico
We don’t really try to factor a viewpoint on that. Look, at the end of the day, what we’re trying to do is we’re trying to, like I said, achieve two objectives with the hedging strategies. We want to protect our funding cost. In order to protect your funding costs, you have to think about it from a hedge ratio perspective. Once we get — and I think the Fed is clear about this, once they get to their sort of the pivot point, you also know where the Fed funds rate is going to go over time, which is going to be materially lower.
If the Fed stops at 5 or 5.5, the Fed’s own projection is still for 2.5 over the long run, right? So we know that, ultimately, the Fed is going to start cutting rates. And then we know the economy is going to be slow, and we know inflation is going to come back in line. So, it’s quite likely that they will have to start cutting rates fairly quickly after they tighten. In fact, I think, historically, if you look back at all of the Fed tightening regimes, and this has been one of the most aggressive ever, I think it’s clear that the Fed typically goes too far.
And in fact, the Fed has acknowledged themselves publicly that, that is their intention is to go too far to be sure that they get inflation under control and that it’s easier for them to ease and to respond to that weakness than it is the other direction. They want to control inflation expectations. So they’re going to go farther than they need to, and then they’ll dial it back to fine tune. So, I think it’s reasonable to assume that eases will come fairly soon after tightening.
Douglas Harter
Okay. I guess moving to leverage. You touched on this a little bit when talking about the volatile environment. But I guess, how do you view kind of your current leverage level, kind of where is that in the range of outcomes? And with your favorable viewpoint towards spreads over the next three, six, nine months, why not be a little bit more aggressive on leverage?
Peter Federico
Well, I think the answer, why not it goes back to — we’re still in an uncertain period, right? We still have to learn a lot about the economic outlook over the next couple of quarters and what the Fed ultimately does. But our leverage level today, what I would characterize, sort of a modest level, the attractiveness and the uniqueness about this environment is that you can generate really attractive returns without taking excessive risk without taking leverage higher, right?
So why not do that? This is a perfect environment to generate really attractive returns. You don’t need to reach to generate those returns. You can operate with a sort of more conservative position, generate excellent returns for your shareholders and not be overly exposed to the market volatility and uncertainty. I think that’s ultimately in the best interest of our shareholders.
Douglas Harter
Got it. And then, I guess, just talk about the health of the financing markets today. You have your own broker-dealers, so you can do direct repo kind of how are the relative advantages of that?
Peter Federico
Yes. Well, having our own captive broker-dealer is a significant advantage, and it helps us in a number of different ways. On the — we run about 50%, 45% of our funding through our captive broker-dealer in a sense it gives us access to wholesale funding. And if you have sufficient scale because it’s a sort of a fixed cost entity, you can generate really positive economics.
We’re not the only one who has one. And so, it can be really positive for our business. It gives you access to cheaper repo funding maybe in the 5 to 10 basis point range. It gives you access to better margin requirements, which gives you more capital efficiency allows you to operate with the same leverage with more excess capital, if you will.
It also allows us to clear our own TBA trades as opposed to using somebody else’s license and having their margin requirement, we can clear our own TBA trades through our captive broker dealer, which again gives us greater capital efficiency. And then the fourth piece, which I think is also significant is from an operational perspective, it allows us to run some portion of our repo overnight, which operationally would be difficult if you were doing that all bilateral.
But when you have a captive broker dealer and you can access overnight that way, it’s really efficient from an operational perspective, not at all intensive, if you will, from an operational perspective, and it gives us access to overnight funding, which can be really attractive. So that’s — the combination of those four things makes that really a significant positive for our business.
Douglas Harter
Great. kind of tying into leverage and the incremental returns. How are you thinking about the attractiveness of raising capital in this type of market?
Peter Federico
You may have asked this question on our earnings call. So — but I’ll repeat sort of some of the thoughts that I was trying to communicate on the earnings call. So first, from a capital raising perspective, we always look at capital markets activities through the lens of our existing shareholders. Is the activity beneficial to our existing shareholders?
And so I often talk about a number of factors. The first would be, for example, is the capital accretive from a book value perspective, are we selling the stock greater than the book value? Ultimately, that generates incremental book value accretion for our existing shareholders. That’s really important. The second, and I know you’ve written about this in the past, is that you have to think about your capital issuance activities from the perspective of your leverage.
I think that’s really important. Are you operating at the right leverage level, your desired leverage level for your existing shareholders? And if you’re not there, then they should take priority and getting to that level. Now you can use capital markets actions buying back stock, for example, it’s at a discount in an environment where you want to raise capital — raise your leverage would make economic sense.
So you have to look at your existing leverage position, say, making sure that you’re at the right leverage level for your existing shareholders. Is it accretive? Are you at the right leverage level? Can you deploy the proceeds quickly, efficiently, attractively, such that you don’t drain on the earnings power of your existing capital base? And then lastly, are you raising it in the most cost-efficient way? At the market issuance opportunities are much more cost efficient, for example, than bought transactions, materially different in cost.
Both can make sense in certain environments for certain institutions, it all depends. We have over the last several years looked more to the ATM program as a way to raise capital. And then there’s one other point on this that I think is sort of new from an investor perspective, and I brought this up on our earnings call is that I think, at some point, you also have to think about your size and what is the most efficient size of your organization when you’re small and you’re trying to gain scale, raising capital can make sense. If you’re large and you get too large, that can be a challenge, particularly in the environment that we’re talking about.
And what I said on our earnings call is that growing our capital base for the sake of growing is not a sufficient condition for us. We think we are operating right now at a really desirable size and scale. If you think about it, the scale part, we’re — have a low cost structure, very efficient cost structure from a percent of equity basis. We’re at a portfolio size that gives us still flexibility to move our position around in a challenging market, that’s particularly important.
So, we’re always thinking about our size and the fact that we’re operating at a desirable size essentially makes capital transactions more opportunistic. You have to think about them from that perspective is that there’s not limitless amounts of capital transactions that we would be willing to do because we like where we are operating. So, to the extent that we do them, they have to be really accretive, they have to be really attractive to our existing shareholders.
That may arise. Right now, we’re trading at a premium to our book value, and we have really for the last several months. But given the outlook for our business and the uniquely positive outlook for our business, I’m not sure that, that premium is as big as it ultimately could be.
Douglas Harter
And then the last question, just kind of how do you think about the dividend level? Do you think it’s sized relative to the investment opportunity and kind of talk about the mark-to-market return of your portfolio, just kind of how you think about the current dividend level?
Peter Federico
Sure. There are a lot of things go into the dividend outlook. What we’re trying to do is generate the best economic return we can for our shareholders. We’re not trying to target a particular dividend. But when I think about the dividend level, one of the, I think, the most critical inputs into that equation first is what is the economic return outlook on the existing portfolio today at today’s prices, right? Not looking at the accounting nuances of your portfolio and how yields are accounted for income is accounted for.
But if you think about it, if you had to sell your portfolio and buy it all back today, what would be the economic return that you would expect on that portfolio. At today’s level, given our portfolio, I think that’s mid-teens. And our dividend yield on book value, not on our stock price, but dividend yield on book value and our economic return outlook are pretty well aligned. And I think that’s the most critical element when you think about the sustainability of a dividend that’s making those two things — making sure those two things are aligned.
Our book value went down a lot last year because spreads widened. So, as our dividend yield went up, our return outlook also went up. And then after you sort of get over that particular hurdle, then you have to think about what is the cost to run your business going forward from an interest rate perspective or what leverage you’re going to operate at. But where we sit today, I think our dividend yield and our economic return are pretty well aligned.
Douglas Harter
Great. With that, we’re out of time. So Peter, thank you for joining us.
Peter Federico
Thank you very much for having me. Thank you for the questions.
Be the first to comment