Invesco Mortgage Capital Inc (IVR) 2011 Q1 法說會逐字稿

This presentation and comments made in the associated conference call today may include forward-looking statements. Forward-looking statements include information concerning future results of operations, our ability to access capital markets, our outlook on the economy, our view on government reforms for the mortgage industry and our ability to capitalize on the changes, our ability to continue performance trends, our level of debt and our ability to obtain additional financing. In addition, words such as believes, expects, anticipates, intends, plans, estimates, projects, forecasts and future or conditional verbs, such as will, may could, should and would, as well as any other statement that necessarily depends on future events, are intended to identify forward-looking statements.

Forward-looking statements are not guarantees, and they involve risks, uncertainties and assumptions. There can be no assurance that actual results will differ materially from our expectations. We caution investors not to rely unduly on any forward-looking statements and urge you to carefully consider the risks identified under the captions Risk Factors, Forward-Looking Statements and Management Discussion and Analysis of Financial Conditions and Results of Operations in our annual report on Form-K and in quarterly reports on Form 10-Q, which are available on the Securities and Exchange Commission's website at www.SEC.gov.

All written or oral forward-looking statements that we make or that are attributable to us are expressly qualified by this cautionary notice. We expressly disclaim any obligation to update the information in any public disclosure if any forward-looking statement later turns out to be inaccurate.

Good morning, ladies and gentlemen. Welcome to Invesco Mortgage Capital Incorporated investor conference call, May 10, 2011. All participants will be in a listen-only mode until the question-and-answer session. (Operator Instructions). As a reminder, this call is being recorded.

Now I would like to turn the call over to the speakers for today, Richard King, Chief Executive Officer; John Anzalone, Chief Investment Officer; and Don Ramon, Chief Financial Officer. Mr. King, you may now begin.

Thank you. Good morning, everybody, and welcome to the Invesco Mortgage Capital first-quarter 2011 earnings call. I am joined today by John Anzalone, our Chief Investment Officer, Don Ramon, our Chief Financial Officer and Rob Kuster, our Chief Operating Officer. We will discuss our results for the first quarter and our outlook for the rest of 2011 and then open it up for Q&A at the end.

We liked the environment we faced in the first quarter, a continued steep yield curve characterized by mildly rising rates and the Fed keeping short rates low. Prepayments on agency mortgages were well-behaved and non-agency prepays remain pretty fast despite the fourth-quarter rise in rates, which extended somewhat into the first quarter.

In the quarter we earned $1.01 per share and paid out $1.00 of dividend. As we've noted in the past, a few factors have combined to cause our return on equity or strategy's gross ROEs to come in higher than we had modeled for, slow pre-pays on agencies and faster-than-modeled prepayments on non-agencies, as well.

We still expect a little slower prepayments in the non-agency space. And with the recent fall in rates, we wouldn't be too surprised to see agency prepays pick up a bit, but they remain very slow at present.

We are targeting gross returns in line with what we've said previous -- pretty consistently, which is 16% to 18% return on equity. And those seem to be achievable to us over the foreseeable future.

The economic environment right now is not too hot and not too cold, but just right, but we are not investing based on a Goldilocks' view. We continue to expect home prices to fall further and we are keeping our non-agency portfolio in cleaner paper, primarily prime, with adequate cushion to generate positive returns in stress scenarios.

And further, we've extended interest rate hedges and increased the percentage of our agency book that we hedge. That will reduce our NIM a bit, but allows us to still generate strong earnings, make our earnings more sustainable at a slightly lower level and perform better in a rising rate scenario.

Let me say a few words about book value. In the first quarter, our book value rose $0.75 to $21.24 as several things went well for us. Mortgage spreads tightened, and our agency portfolio outperformed the broad agency mortgage market. CMBS rallied strongly and our interest rate hedging paid off.

We are set up well for rising rates, and empirically, our book value is performing better when rates rise than when they fall despite the positive duration gap.

On capital, the capital raise we completed was meant to accomplish many things, in addition to the opportunity on the asset side -- to improve our book value, continue to lower expense ratios, add to scale, making us more competitive for the future, and increase our stock's liquidity. On the asset side, we were efficient in getting the new capital to work to minimize drag, and we moved our equity allocation as we desired.

We believe for the rest of 2011, there will be no recovery in housing and the government -- the budget headwinds will keep growth contained and the Fed on hold. We hedge pretty heavily because of concerns with financing the deficit and the realization that the Fed cannot control long-term rates for the long-term, and this summer is the end of QE2.

We are excited about being able to generate mid to high teens ROE. We like having a portfolio that generates more income and book value when rates rise. For now, we see agency mortgages as the best opportunity among many appealing strategies, and we look forward to benefiting from the coming changes in the market as the government embarks on a quest to reduce their market share in favor of private capital.

Don will now go over the first-quarter financials.

Thank you, Rich. During the first quarter, we benefited from the capital raise completed in December. By quickly investing the funds, we were able to increase our net interest income 31%, which was the key driver of our Q1 net income of $53.7 million.

For the March follow-on offering, the majority of the assets purchased settled late in the month or early April. As a result, we did not realize any significant income in Q1 related to this offering. As the funds will have been fully invested for the majority of the second quarter, we do not anticipate any real drag on Q2 results related to that raise.

In addition to our net interest margin, we also saw gains of $2.5 million from our credit default swap investment, of which $1.4 million was an increase in the fair market value of the swap that flows through the P&L and the other $1.1 million was the interest income on the swap. The other component was a gain on sale of MBS that netted $1.2 million.

For the quarter, our EPS was $1.01, and we paid a dividend of $1.00, as Rich mentioned earlier.

Turning to page 4, you can see that while our portfolio is increased in size, performance in our key measurement areas was consistent with Q4. Gross ROE improved 90 basis points to 18.3%, again, as proceeds from the December offering were fully invested.

On the lower left, you can see that our portfolio yield, cost of funds and net yield were unchanged from Q4 as we continue to invest in assets with similar returns and leverage levels.

In the lower right, you can see that we improved our operating efficiency another 12 basis points from the December offering. While this has been a very positive trend over the last year, we are approaching our maximum efficiency level and will probably only see minor changes from this point forward as the rate approaches our 1.5% management fee.

Now I will turn it over to John to discuss the details of the portfolio.

Thank you, Don, and thanks again, everyone, for joining us on the call this morning. I will start off with the portfolio update on slide 5. As you can see, our assets grew substantially since year-end, largely reflecting the impact of the capital raise in March. That follow-on was quickly invested as proposed, 60% in agencies and 40% in credit assets.

The flexibility of the hybrid strategy allows us to rotate into the sectors that offer the best risk-adjusted return at any given time, and this has allowed us to maximize returns while keeping a stable book value profile.

Right now, agency mortgages offer the best opportunities, as funding costs remain low and the prepayment environment is benign.

Opportunities remain on the credit side on a select basis, and we have been successful in putting money to work there. Overall portfolio leverage declined at quarter-end due to unsettled trades from the March capital raise, but adjusted for this, our leverage is approximately 5.3 times.

Slide 6 provides a closer look at our equity allocation and how it has evolved over time. As you can see, our allocation to agencies has increased quite a bit since the third quarter, as the environment for that sector has been ideal, and I will talk about that in more detail in a minute.

That said, we continue to run a portfolio that is roughly 50% agency and 50% credit, once unsettled trades are accounted for.

The benefits in the diversified portfolio are significant, as the different asset pockets behave differently in different environments. This translates directly to a more stable book value profile. Further, our flexibility allows us to go after the best opportunities available and we continue to take advantage of that ability.

As I previously mentioned, we believe this is a very good environment for agency mortgages. Funding costs are still very low, averaging in the low 20s for a one-month repo. Hedging costs are relatively cheap and the prepaid and outlook is extremely favorable. We continue to focus on higher coupon pools in both 15s and 30s, and strongly favor pools where the underlying loans have characteristics that make their propensity to prepay much lower.

Specified pools that contain loans with very low balances or high percentage of investment properties are examples of this.

We also began to invest in hybrid arms during the quarter, as the valuations on those pools became attractive. Once again, we had outstanding prepay performance out of the agency book, with CPRs of 13.4 for a 30-year collateral, 9 for our 15-year collateral and 6.4 for our agency ARMs. This performance continued with last week's print for April, where our overall agency book paid approximately 8 CPR. Our ability to select pools that exhibit this type of prepay performance has been a key driver of returns for us.

Finally, we've increased our hedging activity and now have 89% of our agency repo swapped.

As you can see on slide eight, our equity allocations to non-agencies has declined with our latest offerings, but our percentages increased to 43% as a result of purchases completed in April. We are seeing increased opportunities in leveraging new-issue Senior Re-REMICs with unlevered yields of 4.5% to 6% and levered ROEs in the mid-teens. We like this trade for a number of reasons.

First and foremost, these bonds are much more insulated from the severe downturn in the housing market, as the subordinate bonds provide us with a great deal of credit enhancement. They are also very liquid and we have seen financing terms and rates continue to improve.

We have purchased both rated and unrated bonds, but have found that ratings have very little impact on haircuts or liquidity. Away from Senior REMICs, we have also continued to invest in older vintage prime and Alt-A.

Finally, in CMBS, we've continued to be active in both the legacy and new-issue markets. Financing terms and rates have continued to improve here also, helping us produce attractive ROEs averaging in the mid-teens. For example, we just refinanced our former COF positions for another six months at terms that were approximately 25 basis points better than our previous levels. With a robust and new-issue pipeline ahead of us, we expect to continue to be active in this sector.

That concludes our prepared remarks, and now I would like to open it up for questions.

+++ q-and-a

(Operator Instructions) Bose George, KBW.

A couple of questions. I was wondering, first, just on the non-agency Seniors that you've been buying -- which I assume you bought in the second quarter -- I was wondering what the yield is on those and where you are funding those securities.

Obviously, the yields are going to vary depending on the bond, but anywhere from 4.5 to kind of the upper 5s is the average yield -- loss-adjusted, unlevered yield. Funding costs, haircuts, anywhere from 12.5% up to 15% seems to be the average on the haircuts. And rates are in the, call it LIBOR plus 100 to 125.

Okay, and these are generally par securities?

Yes, give or take a few points, but they are generally right around par.

Okay. And then just from the comments you made earlier, it sounds like the downgrade risk is limited just because the market cares -- doesn't focus too much on what the rating agencies say. Is that a fair view?

That's generally true. I mean, we've seen slightly better haircuts on rated securities because our lenders have capital -- because of capital reasons. But generally speaking, we haven't seen that they trade any differently or that there is any real liquidity differences like that.

Okay. And then just switching to the credit default swap income that you are getting, actually I forget -- is there capital allocated to that? Like, can we think of the return there as kind of an ROE, or how should we think about them?

Bose, it's Don. That's the way to look at that. We have to put up cash associated with that. I think you may remember, last time, it was around $22 million or so in cash that we kind of hold. So that is kind of the way to look at it, and it goes down with the notional amount as the notional amount declines.

Okay, great. Thanks a lot.

Trevor Cranston, JMP Securities.

A little bit about how are you thinking about hedging some of your non-agency and CMBS positions now that you are using a little bit more leverage in those sectors. And also, maybe talk a little bit about since you are extending the terms of the hedging on the agency, whether or not you guys have started to use any other instruments, like swaptions or caps or anything like that. Thank you.

Sure, Trevor. We are assigning duration to the par type bonds, whether it be CMBS or non-agencies, the Senior Re-REMICs. So we include that duration number in our GAAP and hedge the overall book with swaps. We haven't done any swaptions. It has all been just swaps.

Okay. And have you guys -- I may have missed it, but did you disclose a duration gap in here anywhere, or can you?

We can. I mean, we've been keeping it, as we said before, between a half and a year roughly, and it is in the middle of that range.

Okay, perfect. Thank you.

Douglas Harter, Credit Suisse.

Thanks, good morning. I was hoping you could talk a little bit about the PPIP investment. I saw that the dollar amount was down and also the earnings contribution was down this quarter. I was wondering if you could just talk a little bit about that.

Sure, yes. On the PPIP side, what we found is there has been, obviously, a considerate amount of rallying in non-agencies. And with one turn of leverage -- you know, when that program began, that financing was really special, obviously. But the private market repos improved to a point where the PPIP financing is really not an advantage. And so we have found it beneficial to actually sell some assets on the PPIP side, return capital, to make it available to finance on the private side.

Now, our Invesco Mortgage Recovery Fund that invests in PPIP also invests in other loan opportunities, nonperforming loans, commercial, distressed properties that our real estate group is turning around. So we do expect that we will have more uptake on that over the remainder of the year. But it won't be on the securities PPIP side; it will more likely be in commercial land and in probably nonperforming loans on the whole loan side. We expect there is going to be increased volume there.

So does that -- as the securities side is winding down, does that cash come back to IVR, or does it stay in the Opportunity Fund?

It can go either way; it depends on the timing. But cash is returned to -- so far, the cash has been coming back to IVR, but it is possible that that could be recycled into other opportunities, depending on the timing.

Great. Thank you.

Jason Weaver, Sterne, Agee.

Good morning. Thanks for taking my question. I was just hoping you could comment on the composition and the timing of those assets that are as of yet unsettled, what is represented by the payable.

Yes, those are -- they are a combination of agencies and non-agencies. Most agencies settle one day during the -- towards the end of the month. So that was mostly the April settles of the purchases we made at the end of March.

And then on the non-agency side, that generally takes a little bit longer to settle. But I mean, I think overall, once everything is done, we were right around -- within a couple percentage points -- of 60% agencies, 40% credit.

I see. Along with that, is your comfort zone on overall leverage still around the 5X to 6X range what you are thinking?

Jason, this is Don. Can you repeat your question, please? We couldn't hear it.

I think you had mentioned previously that your comfort zone on overall leverage was around 5X to 6X. Is that still current?

Yes, I think that is a good place to be. I mean, as you see, if we -- if you take into account the settled transactions and so forth that were pending and so forth, that would have put us at about 5.3 as the portfolio was finishing out the ramp at that point. So somewhere between 5.5 and 6 is probably a good place to put us.

Okay, thank you.

Obviously, a lot of that depends on the mix of assets. And as we increased agency allocation, the leverage goes up. And also, as we -- on the non-agency side, the Senior Re-REMIC trade, we put more turns of leverage on that than we would on a lower dollar price fund, obviously.

Thanks, guys.

Daniel Furtado, Jefferies.

Thanks for taking my questions. This increased focus on the Senior Re-REMIC, is that basically due to the fact that there is more availability of leverage for those assets?

That is -- I mean, you know, there are a number of things that are attractive about it. First and foremost is just the credit profile of those bonds. They are pretty bulletproof when you look at stress scenarios.

And then because of that, obviously, lenders are much more comfortable advancing higher amounts against it, so that is a benefit.

The other thing is the extension risk on those bonds is very attractive. So if you look at that, say, relative to another clean opportunity, like agencies, you have bonds that have cushioned extension risk because of the Junior piece.

Okay, that makes a ton of sense. Now, are you seeing anything -- or I know that the Maiden Lane type assets aren't really in your wheelhouse, as far as I can tell. But are you seeing any impact from the Maiden Lane sales on your business or how you approach buying bonds in the market today?

Yes, the Maiden Lane sales, you're right -- they have not been in our wheelhouse in terms of types of risk profiles that we find attractive. We have seen limited impact on -- like the Senior REMICs, I don't think have been impacted much at all -- very, very -- not materially, I would say.

What we've seen is in subprime and kind of that dirtier Alt-A type paper has started to feel the impact a bit. I know they are continuing with sales even this week, so I know that's -- we'll kind of see how that goes. But it has definitely weighed on the subprime market and, to some extent, some of the option ARM and sort of dirtier Alt-A.

Excellent. Thank you. And then my last question is the CDS gains, how do we think about those from like a cash flow perspective? Is this recurring income you get for the quarter, or is this a book marked to market on the agreement itself?

Dan, there are two components of it. One is when you look at the -- again, as I mentioned, the interest income on it, the $1.1 million, that is cash income that is received on a regular quarterly basis.

The other portion of it, the gains, the unrealized gain would be the $1.4 million that came in this particular quarter. And again, that would be realized over time, but again, that is a mark-to-market gain that has to flow through the P&L, but there is no cash associated with that.

Go you. I missed the comment earlier about the $1.1 million in interest income. Thanks for your time, guys. Good quarter.

(Operator Instructions) Mike Widner, Stifel Nicolaus.

Good morning. Sorry -- I got on a little late and apologies if you answered this one already. But just looking at the equity allocation here you had on page 6, and then doing some quick math on data on applied leverage there, you took the allocation of equity on the agency side up a fair bit. But then as I look at the portfolio, it looks like the leverage effectively came down -- I got you about 5 times on that portfolio. I was just wondering if you had any comments on that and how should we think about that.

Mike, I think probably, as John said, we -- in this recent raise, we put about 60% into agency, 40% into credit, and that did raise our equity allocation to agency.

On the leveraged side, I think probably what you are seeing is masked by the forward settlements. So that is -- we've given the guidance that we think overall leverage actually is going up in the 5.5 to 6 range.

Okay, got you. So specifically, you've got some -- and I guess I saw that in the press release -- you've got some forward settles that you obviously don't have repo against yet, since they are not settled.

Right. I mean, they were regular settle, but they are April (multiple speakers).

Got you. Okay. And then -- so from a leverage standpoint then. Even -- so you said sort of 5.5, 6 -- even that is a bit lower than you guys had been. Is it not?

No, we've been lower -- on an overall basis; we're not talking about just the agency portfolio.

Oh, okay. So you are saying total overall leverage, once everything is settled out, in the 5 to 6.

Right.

So that is actually higher than where you've been kind of historically.

Correct, and that is because more allocation to agency, which is running higher than credit. And then also more in the Senior Re-REMIC trade, which is higher leverage than just the legacy underlying lower dollar price stuff.

Yes, understood. Well, apologies if you went through that already and I missed it, but thanks for the clarity and congrats on a solid quarter and the capital raises.

Thank you.

Mr. King, there are no further questions from the phone lines at this time.

All right, thanks, operator, and thanks, everybody. Appreciate it.

Ladies and gentlemen, that does conclude the conference for today. We thank you for your participation and ask that you please disconnect your line.