Invesco Mortgage Capital Inc (IVR) 2020 Q4 法說會逐字稿

Welcome to Invesco Mortgage Capital Inc.'s Fourth Quarter 2020 Investor Conference Call. (Operator Instructions) As a reminder, this call is being recorded.

Now I would like to turn the call over to Jack Bateman in Investor Relations. Mr. Bateman, you may begin.

Thank you, and welcome to the Invesco Mortgage Capital Fourth Quarter 2020 Earnings Call. The management team and I are delighted you've joined us, and we look forward to sharing with you our prepared remarks and conducting a question-and-answer session.

Before turning the call over to our CEO, John Anzalone, I wanted to provide a reminder that statements made in this conference call and the related presentation may include forward-looking statements, which reflect management's expectations about future events and our overall plans and performance. These forward-looking statements are made as of today and are not guarantees. They involve risks, uncertainties and assumptions, and there can be no assurance that actual results will not materially differ from our expectations. For a discussion of these risks and uncertainties, please see the risks described in our most recent annual report on Form 10-K and subsequent filings with the SEC. Invesco makes no obligation to update any forward-looking statement.

We may also discuss non-GAAP financial measures during today's call. Reconciliations of these non-GAAP financial measures may be found at the end of our earnings presentation. To view the slide presentation today, you may access our website at invescomortgagecapital.com and click on the Q4 2020 Earnings Presentation link under Investor Relations. Again, welcome, and thank you for joining us today.

I'll now turn the call over to John Anzalone. John?

Good morning, and welcome to IVR's fourth quarter earnings call. I will give some brief comments before turning the call over to our Chief Investment Office, Brian Norris, to discuss the current portfolio in more detail. Also joining us on the call to participate in the Q&A are our President, Kevin Collins; our CFO, Lee Phegley; and our COO, Dave Lyle.

I'm pleased to announce that core earnings came in at $0.10 per share for the quarter, exceeding our recently increased dividend of $0.08 per share. Book value was $3.86 at quarter end, which represents an increase of 11.2% for the quarter. The combination of the increased dividend and our book value appreciation produced an economic return of 13.5% for the quarter.

The improvement in book value has continued since quarter end as we estimate that book value was up approximately 5% through last Friday, with those gains concentrated in January and relatively flat performance so far during February.

During the fourth quarter, financial markets continue to recover as the impact of stimulus programs and optimism around the rollout of vaccinations began to take hold. Risk assets across fixed income continued to benefit from strong investor interest, and ABC mortgages, in particular, had a strong quarter. Consistent demand for current coupon agency mortgages from the Federal Reserve and commercial banks outweighed elevated issuance, leading to a strong performance for the sector.

At IVR, we have largely completed our reallocation to Agency MBS, ending the year with 98% of our assets in agencies. We continue to take advantage of the strong demand for credit assets by further reducing our credit book by $336 million, resulting in a credit portfolio of $161 million at quarter end.

Our liquidity position remains strong as we ended December with a $745 million balance in cash and unencumbered assets.

Earlier this month, we successfully completed a common stock offering with net proceeds of approximately $103 million that was deployed into additional agency mortgages. This will allow us to build upon our success in restoring core earnings while adding scale and helping to balance our capital structure.

As we look out over the next several quarters, our outlook remains relatively constructive. We remain positive on agency mortgages as we expect demand from the Federal Reserve and commercial banks to remain strong, while the steeper curve and recent underperformance keeps the ROE and new investments attractive.

Funding costs should remain attractive as well as we expect the Fed to keep short-term interest rates low for the foreseeable future. Despite the recent widening, agency mortgage valuations remain rich and along with increased levels of prepayments present some potential headwinds for the basis. However, our focus on active management and security selection and purchasing specified pool collateral helps to mitigate these risks.

I'll stop here and let Brian go through the portfolio.

Yes. Thanks, John, and good morning to everyone listening to the call. We added a couple of slides to the presentation and are hopeful they provide a little more background and insight on recent financial markets in general, and more specifically, the Agency RMBS sector, given the particularly attractive environment and our increased focus on the sector during the second half of 2020.

I'll begin on Slide 4, which details the changes in the U.S. treasury yield curve over the past 12 months in the upper left-hand chart. Positive developments in regards to the COVID-19 vaccine and an improving economic recovery led to a bear steepening move in interest rates as the short-end remained anchored, while the 10-year and 30-year both increased approximately 20 basis points during the quarter.

The upper right-hand chart indicates the impact monetary policy has had on short-term funding rates, which remain subdued during the quarter and continue to be attractive for borrowers in the short end of the yield curve.

Financial market volatility in the bottom left was also impacted substantially by monetary policy and continue to diminish into year-end despite a modest uptick as we approach the November elections in the U.S.

Lastly, in the bottom right chart, we detailed the growth in both U.S. Bank and Federal Reserve Holdings of Agency RMBS, which had a significant impact on Agency RMBS valuations as we enter 2021. Despite net issuance close to an all-time record at $210 billion in the quarter, the combination of the Federal Reserve with a prescribed $120 billion of net purchases and commercial banks with over $200 billion of net demand during the quarter, produced impressive hedge returns in the asset class, particularly in lower coupon 30 years as the primary beneficiary of the demand from both entities. These totals resulted in net demand for the year of over $600 billion for the Fed and $500 billion from banks, overwhelming the historically high $500 billion of net supply.

Moving on to Slide 5, where we provide more detail on the Agency RMBS market. You can see the impact, strong supply and demand technicals had on lower coupon valuations during the quarter, driving treasury spreads significantly tighter in the upper left-hand chart.

Specified pool payouts, as shown in the upper right, were modestly weaker and lower coupons as interest rates rose, diminishing the need for prepayment protection, while higher coupon pay-ups stayed well supported as prepayments remained elevated for borrowers that continue to have significant incentive to refinance at current low mortgage rates.

The chart in the lower left shows the significant increase in prepayment speeds for lower coupon mortgages during the year as historically low mortgage rates and increasingly efficient refinancing drove speed near all-time highs.

Finally, the lower right-hand chart shows the implied financing rate for dollar roll transactions in 30-year 2%, 2.5% and 3% TBAs. The implied financing rate is the reinvestment rate for which an investor is indifferent between taking delivery of a mortgage pool or rolling the TBA contract forward 1 month and investing the cash elsewhere.

As indicated in the chart, volatility and dollar roll attractiveness increased during the quarter as implied financing rates improved for higher coupon 30-year 2.5 and 3s and were weaker for 30-year 2s. Dollar rolls trading with implied financing rates below 0% indicate a particularly attractive environment for investors. And while lower coupon TBAs are not rolling quite as well as they were late in the third and early in the fourth quarters, they still provide investors with improved funding levels for Agency RMBS relative to short-term repo in a highly liquid security.

Slide 6 provides detail on our Agency RMBS investments. As indicated in the upper left-hand chart, in addition to the 18% allocation to Agency TBA, our Agency RMBS portfolio is well diversified across specified pool collateral types. We remain focused on lower-priced collateral stories, mitigating our exposure to elevated pay-ups at historically tight spreads as our specified pool holdings had a weighted average pay-up of 0.8 points as of 12/31.

We purchased $3.1 billion of lower coupon 30-year specified pools during the quarter while rotating out $491 million of underperforming pools, underscoring our active management strategy within the portfolio and the superior liquidity of the asset class.

In addition, we added $800 million notional of lower coupon 30-year TBA, increasing our allocation from 14% at the end of the third quarter to 18%, as dollar rolls remain an attractive and highly liquid alternative to holding specified pools and financing them via short-term repo.

Our specified pool holdings paid 3.9% CPR during the quarter as our relatively newly issued pools at a weighted average loan age of 5 months at quarter end. We anticipate prepayment speeds on our holdings will increase as our holdings move up to seasoning ramp, but the increase in speeds should be mitigated by the recent move higher in interest rates and wider spreads in Agency RMBS. We remain focused primarily in 30-year 2% and 2.5% coupons, as those coupons provide the most attractive combination of lower prepayment speeds and strong support via consistent Federal Reserve and commercial bank demand. While we anticipate the elevated net issuance experienced in 2020 to continue into 2021, we expect Fed demand to absorb the net issuance, while bank demand, though unlikely to match the total in 2020, should provide sufficient support as bank deposits continue to outweigh loan growth.

Our remaining credit investments are detailed on Slide 7, with non-Agency CMBS representing nearly 70% of the $161 million portfolio. As John referenced on Slide 3, we sold $336 million of credit investments during the quarter as strong demand for our assets provided attractive exit opportunities. The continued reduction of our credit portfolio allowed us to increase the allocation to Agency RMBS, which increased the earnings power of the company while increasing the liquidity and reducing the credit risk within the portfolio.

Our $121 million of remaining credit securities are high quality with 72% rated single layer or higher, and we remain comfortable with the credit profile of our remaining holdings. Although we anticipate limited near-term price appreciation, given the significant improvements experienced since the lows were reached in the second quarter of 2020, we believe these assets are attractive holdings as 100% are held on an unlevered basis and provide attractive unlevered yields.

Lastly, Slide 8 details the growth of our funding and hedge book during the fourth quarter as shown in the chart on the upper left. After paying off our secured loans at the FHLB in August, all of our remaining credit holdings are held on an unlevered basis, eliminating the mark-to-market funding risk on that portion of our book.

Repurchase agreements collateralized by Agency RMBS grew to $7.2 billion as of December 31, and hedges associated with those borrowings also grew during the quarter to $6.3 billion notional of fixed to floating rate interest rate swaps.

We continue to take advantage of low interest rates further out the yield curve to lock in low funding costs via longer maturity hedges with a weighted average life of 6.7 years at year-end, given the potential for a steepening yield curve as the Federal Reserve keeps short-term rates anchored for the foreseeable future. The modest increase in interest rates on our hedge book represents the growth of our portfolio and the rising interest rate environment experienced in the fourth quarter, while rates on our repo borrowings continued to drift lower during the quarter and into 2021, with 1-month repo rates for our Agency RMBS holdings averaging 21 basis points at year-end.

Our economic leverage, when including TBA exposure, increased from 5.1x debt-to-equity on September 30 to 6.6x debt-to-equity as of December 31, indicating further progress towards the transition to an agency-focused strategy. Economic leverage since year-end is modestly higher, estimated at 7.1x as of Friday, as deployment of proceeds from our February capital raise into Agency RMBS investments financed via short-term repo increased company leverage to our current target.

To conclude our prepared remarks, we are very pleased with the transition of the portfolio and our ability to restore meaningful dividends for our investors during the second half of 2020. The Agency RMBS market continues to be well supported by the Federal Reserve purchase program as well as commercial bank demand and robust demand for our credit assets has provided us with opportunities to reallocate equity into Agency RMBS. While the prepayment environment in Agency RMBS remains challenging, we believe our careful selection of prepayment protection, active management and higher mortgage rates will mitigate the potential for faster prepayment speeds and their negative impact on yields. In addition, while Agency RMBS spreads appear tight, recent underperformance and bear steepening of the yield curve will benefit reinvestment opportunities.

Lastly, monetary policy remains very supportive, and we expect that to continue throughout 2021 as the Federal Reserve communicates the desire to maintain an accommodative stance over the medium term.

Thank you for your continued support for Invesco Mortgage Capital, and now we will open the line for Q&A.

(Operator Instructions) And our first question is from Doug Harter with Crédit Suisse.

Hoping you could talk a little bit about the capital deployment, kind of what types of returns and spreads did you see kind of when you were putting that money to work? And then also you said that, that leverage is now 7x, I guess, if you could just put that in context of, if given -- if spreads were to widen a little bit more, do you see if you would have room to kind of take that up a little bit or how you're thinking about the range of leverage?

Yes. Doug, it's Brian. I can talk a little bit about the deployment of proceeds. We basically reinvested those proceeds into lower coupon agency mortgages. So similar to kind of how we built the portfolio over the last couple of quarters. ROEs on those, we're talking in early February, ROEs on specified pools were right around 10%. So call it, maybe 9% to 11% range, whereas we also added some Agency TBA as well. And at the time, Agency TBA was kind of mid- to high-teens ROE. So since then, we've -- over the last couple of weeks, we've seen the agency mortgages underperform, and we've seen ROEs improve a decent amount, maybe, call it, 200 basis points kind of bump that up to 11% to 13% for specified pools.

So with leverage right around 7%, it's kind of where we've intended it to be, but it does give us room, if this kind of continues and ROEs can become more attractive, we can add to that, certainly.

Great. And I guess if you could just talk -- you mentioned that this capital raise was kind of used to rebuild -- kind of help continue to rebuild kind of core earnings. If spreads continue to kind of get more attractive, what would your appetite be for raising additional capital?

Yes. Doug, this is John. Yes. I mean, I think we're going to raise capital if we see opportunities for it to be accretive. This one was accretive to ROE, certainly. And also, I mean, I think, helping to rebalance the capital structure to better balance between our common and preferred is another goal.

So I think -- I mean, if the opportunity presents, we'll certainly look at that, especially given where ROEs are certainly, if we were to put money to work now or in the near future, we think it would be very accretive to core. So yes, I mean, we definitely look at that.

Our next question is from Trevor Cranston with JMP Securities.

You guys mentioned the recent underperformance of mortgages a couple of times in the prepared comments, and I think I heard you say, John, that book value in February was about flat. I was wondering if you could just help us kind of square those 2 factors and comment on if there was any changes to the portfolio or the hedge book that helped the book value stay flat despite the underperformance of MBS?

Yes, this is John, and -- Brian, you want to go?

Yes, I can take that a little bit. So yes, we had released an estimated book value range at the end of January, which was kind of where we were as of Friday. So we saw a decent amount of gains in the early part of February. But over the last, call it, 10 days or 12 days or so, mortgages have underperformed. So they kind of came back down to where we were flat through Friday.

Okay. I got you. That's helpful. I guess more generally, rates have obviously been trending a little bit higher, can you guys talk about how you guys think about extension risk within the portfolio and how you guys are approaching managing that conceptually?

Yes. Certainly, as rates rise and given the makeup of our portfolio, there's going to be some extension in our bonds. And we've been hedging pretty long since we started this kind of rebuild in the third quarter. So longer-dated swaps even out to 30 years to help protect us from that.

Okay. Got it. And just to clarify, on the deployment of the proceeds from the offering, was any of that capital deployed into TBAs or was that primarily deployed into spec pools?

Yes. Some of it was in the TBAs, just to kind of keep our allocation. We like -- given where -- how attractive TBAs are, we kind of like the allocation in that upper teens area. So with the new capital, we pretty much invested it to keep it there.

At this time, I'm showing no further questions.

Sorry, did you say no more questions?

Yes. I'm showing no further questions at this time.

Okay. Well, if there's no more questions, thanks, everybody, for listening, and we will see you next quarter. Thanks.

Thank you for participating in today's conference. All may disconnect at this time.