Invesco Mortgage Capital Inc (IVR) 2020 Q2 法說會逐字稿

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

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

Thank you, and welcome to the Invesco Mortgage Capital Second 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 differ materially 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 Q2 2020 Earnings Presentation link under Investor Relations.

Again, welcome, and thank you for joining us today. I'll now turn over the call to John Anzalone. John?

Okay. Thank you. Good morning, and welcome to Invesco Mortgage Capital's second quarter earnings call. I will give some brief comments before turning the call over to our Chief Investment Officer, Brian Norris, to discuss the current portfolio in more detail.

The second quarter was an eventful one. In the beginning of the quarter, the financial markets were still in the midst of an unprecedented liquidity event as economic activity shut down to combat the COVID-19 pandemic. As we noted in our last update, this triggered dislocations across the structured security space that impacted our ability to meet margin calls. In response to the crisis, we took a number of steps to increase our liquidity position while reducing leverage.

Over the course of the quarter, we sold $6.9 billion of investments and repaid $6.3 billion of repurchase agreements. We also reduced our secured loans by $610 million. We elected to hold $1.6 billion of mostly non-Agency CMBS and GSE credit risk transfer paper that would benefit as market conditions improved. On Slide 3 of the deck, you can see a breakdown of the composition and credit quality of these holdings as of 6/30.

Slide 4 provides more details about our response to the dislocations in the financial markets that we saw at the end of March. Our immediate goals were to reduce our exposure to mark-to-market financing and credit assets, to increase liquidity and to retain credit assets that we felt were poised to benefit as markets recovered. To that end, we were successful in eliminating our credit repo entirely. At quarter end, we only had $740 million of secured financing left, and we've continued to reduce that number in July. This led to a decrease in leverage to 0.6x at 6/30. We improved our liquidity position, increasing our cash and unencumbered assets by $585 million to $825 million. Finally, the credit assets that we retained have benefited from the market recovery, and we have used proceeds from further sales to begin to invest back into agency assets.

I'll wrap on Slide 5. As we move forward into the second half of the year, our goal is to restore meaningful core earnings for our shareholders. This would involve redeploying capital away from our credit positions as we make opportunistic sales into agency mortgages, which will provide income generation and liquidity. On the credit side, we will continue to look for opportunities that are not reliant on short-term mark-to-market financing to generate an attractive return.

I'll stop here and let Brian discuss the current portfolio and our go-forward strategy in more detail.

All right. Thanks, John, and good morning to everyone on the call.

I'll begin on Slide 7, which details the progress we've made in July towards the strategic transition John discussed in his prepared remarks. Given our success in building liquidity and reducing our reliance on short-term mark-to-market financing on our credit investments during the second quarter, we began the month of July with ample liquidity and repo capacity to begin implementing the transition towards an Agency RMBS-focused strategy.

Our Agency RMBS purchases in July totaled $2.2 billion in 30-year low coupon specified pools, as detailed on Slide 7. We were able to source attractively priced new issue collateral stories, including loan balance, low FICO, high LTV and geo pools, which consist exclusively of borrowers in slower paying states such as New York, Florida and Texas. We also focused a significant portion of our purchases on lower pay-up stories such as those originated and serviced exclusively by banks in order to mitigate our exposure to pay-up premiums. To hedge our funding cost and interest rate exposure associated with these purchases, we executed $1.8 billion of interest rate swaps with maturities between 4 to 7 years.

In addition to our purchases, we sold $547 million of credit assets in July as the recovery in prices continued with strong demand during the month. In particular, higher-quality CMBS was the beneficiary of the June launch of the TALF program, as spreads tightened dramatically in the AAA- and AA-rated assets we finance at the FHLB through our captive insurance subsidiary. We sold $470 million of these assets and were able to pay down $435 million of advances from the FHLB during the month, resulting in a secured loan balance at the FHLB of $305 million as of July 31. The remaining $77 million of sales consisted of a mixture of lower-rated CMBS and CRT, which we held on an unlevered basis. Prices improved on these assets as well, and these dispositions allowed us to deploy capital into Agency RMBS. Price appreciation in our credit and Agency RMBS investments during the month of July contributed to the improvement in our book value, which is up approximately 5% since June 30.

Slide 8 (sic) [7] details the seasoning and senior capital structure positioning of our remaining credit investments as of July 31. As shown in the chart on the left, our credit assets consist of predominantly seasoned investments with over 80% of our holdings issued prior to 2015. In addition to the benefits of seasoning, given the improvement in property valuations over the past 5 years, our holdings also benefit from substantial credit enhancement, as detailed in the chart on the right. 88% of our CMBS holdings have subordination levels in excess of 2007 vintage cumulative collateral losses. Not surprisingly, loans originated in 2007 have experienced notable losses given they've had to endure the global financial crisis and don't benefit from recently improved underwriting. In addition, 94% of our remaining credit investments are rated investment grade, with 81% rated single A or higher. We believe material price appreciation potential exists in our credit investments, and we'll continue to selectively reduce our credit exposure as opportunities arise to dispose of assets at attractive levels.

I'll finish my prepared remarks on Slide 9 (sic) [8], which summarizes the value we bring to our investors as we all continue to navigate the lasting impact of the COVID-19 pandemic on our economy and the financial markets.

As previously mentioned, we believe a strategy focused on Agency RMBS can deliver attractive risk-adjusted returns, primarily through dividend income and secondarily through capital appreciation. Given the consistent message from the Federal Reserve on the medium-term outlook for monetary policy and their ongoing support for the asset class, its exceptional liquidity and readily available and attractively priced financing, we believe the strategy focused on Agency RMBS will deliver on our objectives of restoring attractive dividend income while prudently managing risk.

Our external manager, Invesco, is a significant and experienced investment manager in the asset class, producing top quartile performance through multiple market cycles, most recently for the 1-, 3- and 5-year periods ending June 30. Invesco remains committed to IVR, and its breadth and depth of resources allows the company to share expenses and explore opportunities without incurring significant costs, resulting in an expense ratio among the most attractive in the mortgage REIT space.

Invesco's large footprint in fixed income, with over $350 billion in assets, allows us to remain an important counterparty for the dealer community with readily available access to traders and the focus a large global investment manager requires. Agency RMBS team at Invesco has been engaged in the management of IVR's portfolio since its IPO in 2009 and has a combined 80-plus years of management and trading experience in the asset class. Also, with just over $1 billion in stockholder equity, our company's size, in relation to the depth of the Agency RMBS market, allows us to capitalize on the relative value opportunities that are more difficult to implement with a much larger portfolio.

In conclusion, we believe the agency-focused strategy, supported by the resources of a global investment manager, will provide the attractive risk-adjusted returns investors are looking for when they select a mortgage REIT. And we look forward to continuing the transition to this strategy in the coming months.

And that ends our prepared remarks. And now we will open the line for Q&A.

(Operator Instructions) Our first question will come from Doug Harter with Crédit Suisse.

Can you help us think about what your spread income would be on the Agency portfolio rotated into in July? And how that would compare to the credit assets that you rotated out of?

Yes. Doug, this is Brian. I can start answering that and if the credit guys want to jump in. On agencies, our NIM is approximately 100 to 125 basis points. So on specified pools that equates to roughly 10% to maybe 12% hedged ROE. And the credit investments, the ones that we're holding unlevered, have book yields that are well below that. But we -- like we said, we expect continued price appreciation there. And so that's certainly supporting our book value and adding value in that way.

Great. And then I guess just help us think about within the agency side, given the appreciation in spec pools and the specialness of TBA is kind of -- what part you're finding most attractive today and where that incremental capital might go?

Yes. We've been finding most value in lower coupons, so 30-year 2s, 2.5 and a little bit in 3s as well. Significant size in whole pools is more difficult in higher coupons. Like I said, spec pools in those lower coupons are still providing kind of very low double-digit ROEs. On the TBA front, that's not something that we've invested in at this point. But it's certainly on the radar, and we're looking to do that here in the near term. And ROEs on TBAs are a little bit more attractive just given the kind of the negative implied financing that you get off there. So those are more like mid-teens.

Our next question will come from Eric Hagen with Keefe, Bruyette, & Woods.

I'm curious what led to the decision not to raise capital back in June and early July since the market was more or less giving you that opportunity? Secondarily, have there been any options you've explored to rebalance the capital structure, including things like tendering for your preferred stocks?

Yes. Eric, it's John. Yes, we look at -- we're always looking at the capital structure, and we're continuing to kind of evaluate our options for kind of getting the preferred common ratio kind of more to our historical levels. So we are continuing to look at that.

In terms of raising capital in the quarter, doing a capital raise, I mean, it was just -- I mean I think it was still a little bit difficult to kind of get that done given the cost of raising capital in -- with the market still kind of in a bit of turmoil. But we absolutely are always looking at different ways to do that.

Okay. Got it. And then what's the plan surrounding the funding for the CMBS portfolio once your line with the FHLB gets wound down by year-end? Do you have any securities that are currently being funded through TALF? And finally, what's the funding rate on your agency repo right now?

Yes. Eric, this is Brian. Yes, hope you're doing well as well. Yes, so I guess I'll answer last to first here. Financing on the agencies are pretty attractive. They're LIBOR plus 8 or 9 basis points, so talking maybe 24 basis points all-in for 1 month repo.

And then we did not finance anything through TALF because those -- that required new purchases. I believe they had to be purchased within a month of kind of putting them into the TALF program. So obviously, all of our holdings are -- have been purchased much earlier than that.

And then lastly, we don't anticipate going back into short-term mark-to-market financing for our credit assets. So the intention is to continue to look for attractive dispositions in that space.

And our next question will come from Trevor Cranston from JMP Securities.

When you guys talk about continuing to hold on to the CMBS book in order to capture continuing expected price appreciation, can you talk about kind of how much you think is left? And if you sort of -- is your view that spreads could get all the way back to pre-COVID levels? And maybe just provide some color on how long you're willing to hold on to the portfolio to capture that potential upside.

Yes. Trevor, this is Kevin. Thanks for your question. I guess I would say that we do think the potential for additional tightening certainly exists. We've been encouraged by the fact that investor demand has continued to increase for credit risk. The U.S. economy has obviously slowly reopened. And we've seen some improving trends, although certainly challenges as well. We were encouraged to see that the TALF program has been extended throughout the rest of the year, which we think gives us certainly at least a couple more, a few more months of, we think, potential upside that exists.

I think the potential for additional appreciation is arguably best addressed by looking at where spreads are today relative to where they were pre-COVID. And if you think about that, the majority of our positions are AA-rated, so again, AA-rated CMBS that are probably trading at, or at least it was at 7/31 when they were marked, around 350 basis points over swaps. And so these same positions traded around 100 to 115 basis points pre-COVID. So it's not to say that we think that we would see full recovery, certainly not in the near term, but we think the momentum is there.

In terms of single A-rated positions, those are probably marked anywhere, and they're very wide-ranging, I would say 350 to 780 basis points at 7/31, maybe at 550 basis points over swap level on average. But those same positions, again, traded around 160 basis points pre-COVID. And our BBB assets looked something more like 900 basis points at 7/31. And those bonds traded as tight as 250 pre-COVID.

So we definitely think that there is room, but we have experienced a fair amount of credit spread tightening over the last couple of months already. And one of the, I guess, favorable backdrops here for us is just a notable lack of supply as new issuance has slowed, as loan originations have declined notably.

Okay. Got you. And then as you guys are redeploying into the agency market, can you talk about the leverage levels that you're sort of comfortable using on that trade right now?

Yes. Trevor, it's Brian. So leverage is ranging in the 7 to 8x. Overall leverage right now is around 2. But obviously, as we continue to transition, that will continue to climb up to that kind 7x debt-to-equity range.

Okay. Got it. And then just one more question on the capital structure. Wondering if you could comment on specifically if something like a swap of common share for preferred is sort of one of the angles you guys have looked at. And if that is something that is feasible or if it -- or if you think it isn't for some reason?

Trevor, it's John. Yes, I mean, that is one of the things we've -- we're evaluating about, whether it makes sense to do a swap like that. So that's one of several things we've been looking at. We're trying to figure out what makes sense for shareholders in terms of -- depending on where we're trading in terms of common to book value and things like that. So as I think once we get past the financials release from last night, we're going to reevaluate where we are and what makes sense for that.

(Operator Instructions) Our next question will come from Jason Stewart with JonesTrading.

Just curious if you could give us some thought on why you avoided the TBA trade in agency, just your thought process there.

Jason, it's Brian. I wouldn't say that we're avoiding the TBA trade. It's certainly something that we're interested in putting on here in the near term, but we had some things that we wanted to get on the books first in July, and that included whole pool, specified pools. So we had to -- first thing was we had to get back in line with the whole pool test. So specified pools were the first way to do that. And then as we move forward, we anticipate the TBA trade to remain pretty attractive over the near to medium-term just given the Fed support and their medium-term outlook. So that's certainly something that we're going to be looking at here shortly.

Okay. Understood. And then on the additional credit assets that don't rely on short-term mark-to-market financing where you could put capital to work, can you give us some color on what you're thinking there?

Yes. So we own roughly $500 million on an unlevered basis away from the FHLB. And those are the bonds that we believe have the most significant upside potential. So we're likely to hold on to those as we realize that potential. Away from that, we're continuing to explore our options in the credit space. It's certainly more expensive to finance on a nonrecourse basis. So opportunities will be fewer there, but it's certainly something that we're going to continue to explore.

And I'm currently showing no additional questions at this time.

Okay. Well, I'd like to thank everyone for joining us, and we look forward to talking to you again in November.

This concludes today's conference. Thank you for attending today's call. All participants may disconnect at this time.