Invesco Mortgage Capital Inc (IVR) 2012 Q3 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 views on the economy, current prices of mortgage-backed securities, the positioning of our portfolio to meet current or future economic conditions, our ability to continue performance trends, our ability to select assets with slower 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 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 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 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 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. 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 the Invesco Mortgage Capital Inc.'s investor conference call October 31, 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. 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 begin.

Good morning, everybody and welcome to IVR's third-quarter earnings call. Before starting into IVR's results, let me just take a minute to acknowledge the hardship that many are facing due to the storm and offer our best to all those affected.

Invesco Mortgage Capital had a very strong third quarter, generating earnings of $0.72 per share on a book value of $20.93, up $2.53 per share or roughly 13.8%. We paid a dividend of $0.65, which that has been steady the last four quarters. In our most recent earnings calls, we have emphasized two primary goals and they have been to maintain stable dividend and also improve our book value. We continue to be pleased with our results in both those regards.

During the quarter, we were focused on accomplishing those two goals by doing three things -- positioning for QE3, increasing our earning assets, and strengthening our balance sheet. First, we position to benefit from QE3. In agency space, we added almost $1.4 billion in the quarter, still continuing to focus on paying up for call protection in agency mortgage pools.

We invested down in the coupon stack into 3%s and 3.5%s since we believe the Fed purchasing would richen lower coupon agency mortgages. This added duration and we allowed the hedge ratio to decline and our duration gap to increase since we expect that mortgage durations were likely to fall with rates. This action improved our book value. Later, in the quarter, we added swaps to bring our GAAP back down in line with the prior run rate.

Second and still an earlier part of the quarter, we focused on the new equity that was available to us due to both asset appreciation and from the proceeds of our preferred offering. We anticipated higher-quality RMBS and CMBS would appreciate because fundamentals were improving in residential and commercial real estate and the supply versus demand technicals were supported because there is negative net supply in both. We added approximately $575 million between RMBS and CMBS and that change has also increased our book value.

Third, we also continued to strengthen the balance sheet. For the quarter, our earning assets were higher, but our leverage was lower falling from 6.3 times to 5.8 times without much change in asset mix. Still a very high-quality portfolio. We also ended the quarter with a higher cash balance of $190 million resulting in a strong balance sheet. Our quality assets, modest leverage and prepaid protected mortgage portfolio should support the stability of book value.

We are excited about IVR's prospects in coming quarters. The housing market is showing real signs of improvement. We are well-positioned for the environment with half of our equity in RMBS and CMBS. We have managed to limit agency prepayment through careful pool selection and we believe that prepays are likely to remain contained.

At the same time, we still have a largely up in coupon mortgage portfolio that we expect to perform well in a modestly rising rate scenario. We are also excited about opportunities to put capital to work in the commercial real estate space, partnering with our Invesco real estate team.

I will take a moment to comment on page 3 of the deck focusing on the very strong quarter of book value improvement. Our agency MBS added $1.17 per share to book value while our swap hedges only decreased book value by $0.21 per share. So with interest rates declining, the agency portfolio performed very well, adding nearly $1 a share to book value.

Our CMBS portfolio increased in value as well adding $0.81 per share and non-agency RMBS added $0.73 per share. We retained $0.09 and ended the quarter with a book value up $2.53 per share. Since quarter-end, despite the selloff in the agency mortgage space, we have seen solid performance in RMBS and CMBS and book value is about unchanged.

Let me emphasize the effect of the book value improvement on the quarter. Reinvestment yields are lower as you would expect, but the roughly $290 million in increased equity due to appreciation in our portfolio has allowed us to add with leverage $1.9 billion or about 12% to principal balance of assets on which we earn yield.

We expect that action, plus the accretive effect of the preferred, will allow us to continue providing a competitive dividend and with a stronger balance sheet. We are still seeing opportunities, as I mentioned, on the credit side, so you should expect to see that more of our capital will be committed to RMBS, CMBS and CRE in the next quarter.

With that, I am going to pass the call to John to go into more detail on our portfolio and our investment strategy.

Thanks, Rich. I will start on slide 4. As Rich mentioned, between the proceeds from the preferred offering and increased equity from strong asset price appreciation, we were able to meaningfully increase the amount of earning assets on our books while actually lowering our overall leverage.

On a market value basis, we increased our asset base by $2.3 billion, which was invested across all three of our sectors. We increased agencies by about $1.5 billion, CMBS by $400 million and non-agencies by $375 million. As you can see on the chart on the lower left, we kept our equity allocation roughly unchanged in the process. Going forward, we expect to increase our allocation to the credit side as we reinvest a larger percentage of cash flows into CMBS and non-agencies.

Slide 5 shows our agency book. Yields on agencies have declined impacted by lower rates, faster prepayments and spread tightening brought on by QE3. As you can see on the pie chart, 75% of our agencies are in 30-year fixed-rate collateral. There are a couple reasons for this concentration. First, the vast majority of prepaid protected pools are backed by 30-year collateral and given the current rate environment, we still favor those types of pools. In fact, over 88% of our fixed-rate collateral has some form of prepaid protection with the rest consisting of either newer pools or well-seasoned pools, which you also expect to be well-behaved.

Prepayment speeds on our portfolio picked up a bit last quarter, about one CPR faster, and we saw a slight slowdown in October's print. Going forward, we expect to see speeds around these levels as capacity constraints in the origination industry continue to be an issue. Upcoming GC increases will also act to depress origination.

While we saw strong price appreciation on agencies peaking just before quarter-end, we have seen the mortgage basis widen since then, which has allowed us to add new investments at ROEs that we project will be in the mid-teens. In fact, the concentrated Fed buying and lower coupons has distorted the dollar roll market, which in turn has caused a cheapening of the type of prepayment protected pools that we favor.

I will move onto slide 6 and non-agencies. We continued to add to our non-agency position during the quarter and our allocation between re-REMICs and legacy bonds remain constant. Yields declined as coupons on our hybrid ARM collateral reset lower and we added new positions at lower nominal yields. Even though we have seen yields decline, we are still very positive on non-agencies for a number of reasons. First, housing fundamentals have continued to improve. We are in the early stages of a sustainable home price recovery. Inventory levels are decreasing and new delinquencies are declining. Non-agencies have upside as housing continues to recover.

Second, the technical backdrop is exceptional. Net supply has been negative and we do not foresee a material pickup in issuance anytime soon. Demand remains very robust as the Fed's QE program is crowding investors out of agencies and into high-quality credit as they search for yield and we continue to see new money enter the sector.

Finally, non-agencies have a favorable convexity profile meaning that their prepayments are much less sensitive to changes in rates and given that the collateral has floating-rate coupons, they require less hedging as rates move.

Finally, let's move to slide 7 and CMBS. Many of the same trends exist in CMBS as in non-agencies. Yields have declined as asset prices have increased and we have moved the portfolio towards higher-quality credit positions. Despite lower yields, we are very positive on CMBS. Fundamentals in commercial real estate are slowly improving as property prices have increased, although still well below peak levels and better quality assets continue to find funding as insurance companies, broker-dealer conduits and the GSEs and multifamily remain active lenders.

CMBS remains a great way to gain exposure to an improving economy. Technicals are robust as the CMBS market is also faced with negative net supply and investors are drawn to CMBS as a way to invest money in investment-grade credit at relatively high yields.

Wrapping up, we are very positive on the investment environment going forward as our ability to invest across the entire mortgage universe has never been more important. With that, we would like to open it up for questions.

(Operator Instructions). Joel Houck, Wells Fargo.

Thanks and good morning. You guys did a nice job at I guess managing through kind of the QE3 environment and obviously we see a nice lift in book value. I guess the question is can you give us a sense for, in the agency business, what is the yield on the portfolio kind of at the end of the quarter? I see the quarter economics on slide 5 where you got a net yield of 1.15%, but marginally, when you look at your portfolio, what is kind of the weighted average yield at the end of the quarter?

Good morning, Joel. This is Don. If you look at the press release, the earnings press release, the best indicator to use is the MBS table that we put out there and you can see that the total yield on the portfolio is 4.23%. I'm sorry, that was the weighted average. If you look at the period-end, it is 3.51%.

That is on the whole portfolio.

On the whole portfolio.

On the agency passthroughs, it would be 3.01%.

3.01%, so it has actually gone up relative to the average in the quarter?

That is correct.

Okay. And can you kind of explain that dynamic in terms of -- I guess the conventional wisdom is that yields have continued to come in, but that doesn't seem to be the case with respect to your agency portfolio.

Well, you have to understand, in one particular case, I mean it looked -- when you look at the yields for the quarter, those also factor in what the prepayment speeds were during the quarter and a different portfolio composition. Again, if we have added assets or made any changes, also changes in prepayment assumptions and where we stand right now, that also would impact the current yield that we are getting out of yield book.

Yes, this is John. I would say that in terms of portfolio composition, I mean we did move part of the portfolio out of hybrid ARMs and into lower coupon 30-year fixed. So that would also account for a little bit of it.

Okay, that makes sense. And then your earlier comment, I just want to make sure I got it correctly, you're thinking of allocating more into the non-agency and the CMBS subsectors?

Yes.

And do you have a sense for like on a capital allocation basis what, within a reasonable range, what we might expect toward the end of the year? I think you guys are --.

We don't have a number that we are putting out there for it. I mean I think, on balance, we will just primarily be moving cash flows more into that space. So it is probably relatively modest, maybe 5%, 10%.

Yes, a lot of it is really driven by the availability of bonds that we like. So I mean it is hard to project where we would like to -- if we could find enough bonds, we certainly would lean a little bit more heavily towards non-agencies and CMBS.

But I think we should add, we are not negative on the agency space. There has been a backup in prices in the agency market since quarter-end and we will look at the outcome of the elections and determine what the best path forward is from there.

Okay, thank you very much, guys.

(Operator Instructions). Bose George, KBW.

Hey, guys, good morning. I'd like to follow up on the comment you made on the mid-teens ROE on agencies. So just to do the math, so the incremental yield is the 3.01% number and then could you just fill in the cost of funds and leverage?

Well, 3.01% is on the agency passthroughs, yes, so --.

That is on the existing book.

Oh, that is. So what would it be just for the incremental stuff?

Incremental. Yes, so for incremental agencies on 30-year fixed, we see yields in the call it 2.5%-ish range assuming a cost of funds of around 1%. So a NIM kind of in the 1.5% ZIP code.

Okay, great. And then just switching to the non-agencies, just curious what the unlevered yields are incrementally for that.

In non-agencies, yes, I would say between 4% and 4.25% for the types of bonds that we are buying. So we are talking obviously higher quality legacy bonds and also re-REMICs are in that range.

Great. And then just finally on your duration gap, I was just wondering, after the readjustment post QE3, is that back to fairly neutral or where does that stand?

Yes, on the duration gap over this year, it has been running like a little over a year.

On a model basis, yes.

Right, on a model basis. So I mean that is something obviously we watch every day and look at it on a model basis and on an empirical basis. And on an empirical basis, we are running pretty close to no gap, but on a model basis, it is longer than a year. We had it out a year and a half or more during the quarter and brought it back down some.

Okay, great. Thanks a lot, guys.

Just to point out, we added about $1 billion worth of swaps, but keep in mind those are, as usual, those are forward-starting swaps. So again, we aren't going to see the interest expense impact of those probably out until 2013 when we have some other swaps rolling off.

Okay, great. Thank you.

Trevor Cranston, JMP Securities.

Hi, good morning. Just to follow up a little bit on the last question about where yields and returns are right now, going forward, are you guys kind of comfortable with where leverage stood at quarter-end or would you be comfortable maybe taking it up a little bit as we see a little bit of spread compression on marginal investments?

I think we are comfortable where it is. I mean the only -- I think if you see a change much, it will be driven more by portfolio mix. So as we are able to add more credit bonds, naturally you will see our overall leverage levels decrease. But I think for each of the buckets, we are probably going to be -- I don't think we are planning on making any big changes there.

Okay. And just to change subjects a little bit, we have seen some of the peer companies recently announce share buyback plans. Can you guys just comment maybe on whether or not that is something you guys have considered and how you would think about kind of the plus and minuses of implementing a plan like that versus investing in the market today?

Trevor, this is Don. Yes, as you may remember, we already have a buyback plan in place that we put in last year and our strategy on using that is always we are looking at opportunities to basically increase shareholder value and if there was a situation in which we felt we were trading significantly below book then that is probably the time that we would use that plan. But, yes, we do have a plan in place already and have for about a year now.

But, at this point, we are still seeing opportunities in the market. We like, as we said, some select RMBS and CMBS investments. So we would be more likely to put the money to work. I think it is a benefit of our hybrid strategy really. We have opportunities across the entirety of the real estate debt markets, so we are not forced to be selecting just from agencies.

That makes sense. Okay, thanks, guys.

Dan Furtado, Jefferies.

Good morning, everybody. Thank you for the opportunity. The first question --.

Good morning, Dan.

Good morning, Dan. Are you there?

Yes, can you hear me?

No.

No, we can't.

Let me pop back in the queue to see if I can't circle back.

Thank you, operator. Let's move onto another call and he is going to call back in.

(Operator Instructions).

Operator, if there are no more further calls, we will go ahead and end the call now.

Mr. Furtado, your line is open if you would like to try again.

I'm sorry, Dan. We still can't hear you.

At this time, there are no further questions.

All right, we will end the call here then. Thanks everyone for listening today.

This does conclude today's conference. Thank you for attending. You may disconnect at this time.