Invesco Mortgage Capital Inc (IVR) 2012 Q2 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 maintain or improve book value, the stability of earnings and dividends, our ability to provide a competitive dividend, our views on the economy, current prices of mortgage-backed securities, positioning of our portfolio to meet current or future economic conditions, our ability to continue performance trends, our portfolio prepayment speeds and the credit quality of our assets. In addition, words such as believes, expects, anticipates, intends, plans, estimates, projects, forecasts and future or conditional words such as will, may, could, should and would as well as any other statements that necessarily depend on future events are intended to identify forward-looking statements. Forward-looking statements are not guarantees and may involve risk, uncertainties and assumptions. There can be no assurance that actual results will not 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's discussion and analysis of financial condition and results of operations in our annual report on Form 10-K and quarterly reports on Form 10-Q, which are available on the Securities 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 Inc.'s investor conference call August 2, 2012. All participants will be on a listen-only mode until the question-and-answer session. (Operator instructions). As a reminder, this call is being recorded.

I would now 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 begin.

Thanks, operator. Good morning, everybody, and welcome to Invesco Mortgage Capital's second-quarter earnings call.

We're pleased to announce earnings of $0.68 and a book value of $18.40. In our first-quarter earnings call in May, we emphasized important areas of focus for us in the second quarter, and those were, most importantly, maintaining a stable book value and providing our shareholders with a competitive dividend. We accomplished each of these goals in the second quarter, primarily by maintaining low agency prepayments, continuing to add duration into the rate rally and maintaining a high-quality credit portfolio. As a result, we also continued to strengthen the balance sheet.

Despite the recent weakness in the US economy, we are decidedly upbeat about IVR's prospects in coming quarters. The housing market is showing signs of life, and that is benefiting the non-agency market. Operation Twist was extended, and we believe the Fed is moving ever closer to QE3, should it be needed. Continued Central Bank intervention and risk aversion will likely keep rates low and may send them even lower. As we have seen, in an unusual investment environment like this fixed-income investors are starved for yield. It's leading them to seek out high-quality cash flows backed by collateral, collateral that is de-linked from all the ongoing uncertainty regarding the European debt crisis.

Investors searching for income are definitely attracted to government-guaranteed debt that yields more than US treasuries. We believe IVR's mortgage investments are well-positioned to benefit in this environment. We have seen a rally in credit that gained strength after the Greek elections and the Twist extension. There has been increasing recognition on the part of investors that low yields are here for a while and that they should consider transitioning away from treasuries because the yield compression in credit assets is likely to continue. For that reason, and the hopeful signs that have emerged in housing markets, we expect non-agency RMBS will perform well, even as the US economy continues to struggle and foreign markets remain under pressure. Agency mortgages have continued to rally as well, due to only modestly higher prepayments, and we do expect this trend to continue.

The conviction behind our strategy is strong. The money raised from our successful preferred offering was invested within days in high-quality bonds as we found some attractive relative value opportunities in credit. At this point in time on the margin, we prefer credit from a relative value standpoint. At the same time, we continue to believe agency mortgages will benefit from the muted prepayment environment and the positive supply/demand dynamic. Most importantly, we see this environment continuing to benefit IVR's book value and our ability to maintain an attractive and competitive dividend.

On July 19, IVR successfully issued $135 million of $25 par preferred stock. I'm also happy to report we will be closing on an additional $5 million today from the greenshoe. We are able to procure a very attractive 7.75% coupon on the shares. We raised the capital because, as I mentioned earlier, we see a great opportunity to buy credit assets. The timing was good on the preferred issuance because that market has seen multiple billions in redemptions and the demand for paper is strong. The result is we have diversified our capital structure in a way that will be accretive to common shareholders. We believe our growth ROE on the new assets should be in the mid-teens compared to the 7.75% coupon on the shares.

Before I turn the call over to John Anzalone, let me take a minute to comment on page 3 of the presentation and focus on book value. In Q2, our agency MBS performed well, adding to book value by $0.62 per share. And with interest rates declining, the agency portfolio more than offset our interest rate swap hedges. CMBS were pretty much flat for the quarter and non-agency MBS were down modestly. We retained $0.03 and ended with book value down $0.02 per share, so very nearly unchanged.

Since quarter end, we've seen solid performance in book value and we expect that trend to continue. The strong agency mortgage performance that we saw in the second quarter has continued but, as noted earlier, we've seen CMBS and RMBS prices rallying. As a result, we would estimate book value is probably up between 4% and 5% post quarter end. While reinvestment yields are lower, we do expect to continue providing a competitive dividend and we are pleased with the strength of the balance sheet.

And with that, I'll pass the call over to John to go through the portfolio.

Thanks, Rich. We were very pleased with the overall performance of the portfolio during the second quarter. We are pleased to report we've had a nice start to the third quarter as well. As you can see on slide 4, the portfolio sector allocations were very stable during the quarter with the small changes attributable mostly to pricing moves. Our leverage increased slightly from 6 times to 6.3 times.

This quarter, we were able to put the proceeds from our preferred offering to work quickly. With these new purchases, we've focused more on the credit side. We continue to see attractive opportunities in both the residential and commercial sectors. The thing that we have discussed in past calls, that this low rate environment will force investors to search for yield in high-quality credit assets, is playing out as we had expected. We have seen strong rallies in both sectors this quarter, attributing to the recent book value growth that Rich just spoke about.

While our focus recently has been in credit, we are still positive on the agency market. Negative net supply, strong demand out of REITs and banks, low volatility, capacity constraints and lending and the prospects of the Federal Reserve embarking on a QE3 focused on mortgages are all favorable factors. Of course, with dollar prices so high, particularly on the types of specified pool collateral that we favor, securities selection is becoming even more important, but we have been able to pick our spots in the agency sector.

On slide 5, we were pleased with the performance of our agency book, especially given the sharp rally in rates that we saw during the quarter. The yield on our book fell to 2.98%, reflecting a combination of slightly faster prepayment speeds and reinvestment at lower rate levels. Our prepayment experience continues to be positive with CPRs on our fixed book remaining in the low teens. More recently, with dollar prices at all-time highs, have shifted our focus a bit. We've moved into our coupon 30-year pools where specified payouts are lower and out of some of our hybrids that are at greater risk of prepaying, given the level of rates. This has been beneficial as the market has signed a higher probability of another round of QE by the Fed.

In non-agency space, we continue to focus on senior re-REMICs with 67% of our non-agency book in that sector. The lower rate environment impacted this sector as well with our yield decreasing to 5.37% due to a combination of hybrid ARM coupons resetting lower and reinvesting at lower yield levels. While prices were marginally weaker during the second quarter, we have seen a material uptick in prices so far this quarter as investors seek out strong fundamental cash flows with relatively high loss-adjusted yields. As I mentioned earlier, we expect this trend to continue.

On slide 7 you'll see that many of the themes that I talked about in non-agencies also apply to CMBS. We saw a decrease in portfolio yields through a combination of putting new assets on at lower absolute yield levels and by repositioning a portion of the portfolio by moving higher in the capital structure. Since the start of the third quarter, we've seen strong price performance in our CMBS book with prices up 2 to 3 points on average. Again, we are seeing the same theme play out in CMBS that we are seeing in non-agencies -- investors that are starved for yield are turning to strong credit stories for yield.

With that, let's open it up for Q&A.

(Operator instructions) Bose George, KBW.

Actually, the first question -- can you just remind me, with the PPIP liquidated, what investments are going to be flowing through that other line item, and do you know what can through this quarter?

The Invesco mortgage recovery fund is called -- still has investments in some commercial real estate. There's the Atlas portfolio that we purchased back in the fall and then also some other distressed commercial real estate opportunities we've seen as well as some non-performing loan on the resi side.

Okay, great. And just in terms of relative value, can you just talk about where you guys see the best relative value for new investments?

Yes. I mentioned we are focusing on the credit side, so we continue to like the senior re-REMIC story in non-agencies. We think that's -- on a loss-adjusted yields basis, that's the best relative value we're seeing. In CMBS we've been active in both new issue, sort of CMBS 2.0, as well as some legacy positions we've continued to add there. So really, in credit, we've been pretty active there. And then on the agency side, we've been much more focused on lower-coupon mortgages. Like I mentioned, we've been moving out of some of our hybrid ARMs that have higher coupons because there's really not a lot of prepaid protection in those pools, so we've been focusing on some of the specified stories down in -- mostly and 30-year 3.5s.

Okay, great. And then just one broader question. I'm just curious if you guys have any thoughts on the whole eminent domain discussions that are going on.

Yes. We think that eminent domain initiatives do not represent a material risk to our non-agency investments. And, basically, we think there's a lack of legal precedent, that the price to loans would have to be purchased out of the trusts that would not -- or at least the ones that are being discussed do not represent fair value, and that the big problem for the municipalities in those jurisdictions -- their future borrowing costs would be prohibitively expensive. The current borrowers that are targeted by the program are performing somewhat better in recent months, so the problem is getting better. Some of those borrowers are getting relief through higher rates and modification, short sales and their rates resetting lower. So we just think successful implementation would provide very incremental benefit to borrowers, but long-term problems for those communities. We are monitoring the situation. But like I said, we don't see it as material to us.

Okay, great, thanks a lot.

Douglas Harter, Credit Suisse.

On the back of your recent preferred deal, could you talk about how big you think that funding source could be for your balance sheet?

Well, we obviously find it a favorable part of our capital structure, but the market is pretty limited in size. So I would say it's like 6% of our capital structure right now. And it's probably unlikely that we can get it significantly higher than that.

I think, Doug, the key thing to think about that is when we look at it, capital opportunities, it's always something that we are evaluating what's going to be most accretive to the Company. And obviously, we like the current situation with the preferred offering and how that was able to add to the common stockholders. But again, we have to evaluate it each time the opportunity presents itself and what the rates on so forth. But it is an interesting opportunity and we will keep evaluating it as we go forward.

Great, thank you.

Trevor Cranston, JMP Securities.

Just to follow up on the comments about higher prices for the credit assets since quarter end, can you talk about where you're seeing yields today versus what you have on your existing portfolio?

Sure. So just in terms of flat-out yields, 30-year collateral, I'd say we are putting on new purchases around 2.5% for specified pool collateral. 15s in ARMs, we see those as significantly lower, so 1.5% to 1.75% on yields on those. So that's why we've been less active in that space, actually reducing our exposures there.

On the credit side, senior re-REMICs, anywhere from 4.25% to 4.5%. CMBS, call it anywhere from 4.5% to 5% for the type of top of the capital structure or higher in the capital structure type bonds. So those are obviously down with rates coming down so much over the past couple of quarters. But we expect things to kind of -- they seem to have leveled out a little bit here.

Okay, that's helpful. And then one other thing -- on the non-agency yields, you guys commented that part of the drop was due to hybrid ARM coupons resetting lower. Do you know how much of the portfolio you expect to reset on a quarterly basis over the next few quarters?

We don't have a set number (multiple speakers) it's not something we can give you right this second, Trevor, but again, it's something we are continuing to evaluate.

One thing I would say, though, is the vast majority of our positions were 2006 and 2007 vintage. So as -- and they are mostly 5-1 structures, So as we go through 2012, you know, there wasn't any really issued in 2008, so there would be -- a large preponderance of them would be done by the end of this year.

There's going to be some disclosure around vintages on the non-agency book in the Q that's coming out later, Trevor; that should help. But it's mostly 2007 5-1s.

Okay, that's helpful, thanks guys.

Jason Weaver, Sterne Agee.

First of all, I think in the first quarter versus just generic Alt-A out there, we were sort of surprised to the upside for your non-agency performance. And then this quarter, it seems like it felt a little bit short. Can you talk about that a bit? And is it endemic to the senior re-REMIC nature versus a normal CMO structure?

You know, I would say the senior re-REMICs are going to exhibit a lot less price volatility just because, if you think about the amount of subordination they have -- and they are also -- they trade very close to par and they are relatively short duration. So they don't really react a whole lot with rates and they don't act as credit sensitive as other things, so they are going to be much more stable in terms of price, whereas -- and as that has become a larger part of our book that has become just more stable in terms of price volatility. So we think that's largely going to be driving our non-agency performance.

Like for instance, since the end of the quarter, our legacy RMBS positions are almost up almost 2 points on average, whereas our senior re-REMICs are kind of flat, given where they are on the curve and given the dollar price and the credit enhancement they have.

Thank you, that's fair. And on the -- you actually touched on this a bit in your answer there. I was going to ask how you think about both for the senior re-REMIC and some of the higher-priced quote sort of par, maybe CMBS 2.0 assets you hold. How do you think about interest-rate exposure there? Do those assets generically trade on spread? And with the durations in the CMBS sector probably being longer, I would expect the 5.1 nature of the re-REMICs to sort of limit the risk there.

Yes. So the re-REMICs -- that's the flipside of what we said earlier. Coupons are resetting. But, at the same time, we have literally no interest rate risk on that part of the book because, as rates go up, the coupons would go up. So we don't have to worry about hedging that.

On the CMBS book, the legacy stuff is pretty short, but the CMBS 2.0 stuff is something that we do hedge the interest rate risk on. So when we look at our overall duration gap, we include the CMBS.

Okay, that's very helpful. Thank you, guys.

[Vic Agarwal], Wells Fargo.

I had a quick question. You had mentioned that you found credit assets more attractive in the current yield environment. Are you -- does it suffice to say that you are potentially going to increase your non-agency allocation from where it sits now to mid-2011 levels?

I doubt it would get that high. I think what we're trying to do is, as we find bonds we like, we are transitioning more the more prepaid-sensitive agencies out of our book and into credit, where we can find credit. The issue on the credit side is really just availability of bonds on the non-agency side because it is a shrinking market. That's one of the reasons we are really positive on it because, right, it's the supply of non-agencies is getting smaller every month. So the positive side is that it's good for the bonds we own. The negative side is that it's a little bit more difficult to add as many bonds as we'd like. But I think we've been pretty successful in doing that, so I think we are taking a fairly measured approach in terms of just doing analysis in finding bonds we like and adding where we can.

Okay, thank you.

(Operator instructions) Gabe Poggi of FBR.

Just a quick question. And if you said it already, I apologize. Can you give us an update on where you saw speeds come in for July on the agency side?

We did not talk about that, but I can give you an update. So yes, the June print -- so that would have been reported beginning of July, the agency book paid 13.5, which was up about a half a CPR from the prior month and not that different than where we paid during the second quarter. We saw 15s were slightly faster, as were hybrids, and we saw a little bit of slowdown in 30s. But nothing -- everything was within kind of a CPR of where it had been the prior month. So --

Perfect, thank you.

At this time I show no further questions.

Okay, thank you, operator. We will talk to you next time.

Thank you. Today's conference has ended. All participants may disconnect at this time.