Invesco Mortgage Capital Inc (IVR) 2014 Q1 法說會逐字稿

This presentation and comments made in the associated conference call today may include forward-looking statements. The words such as leaves, expects, anticipates, intends, plans, estimates, projects, forecasts; and future conditional verbs such as well, 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's discussion and analysis of financial conditions 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. 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. investor conference call. (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 and welcome to the first-quarter 2014 Invesco Mortgage Capital earnings call. IVR's management team believes we can deliver optimal shareholder value over the long term by managing risks to provide relative book value stability and by producing a high level of current income to shareholders -- income generated through core earnings and passed along to common and preferred shareholders in the form of dividends.

With that in mind, we have been addressing book value stability and maintenance of strong core earnings, both through the asset and liability side of the balance sheet, as well as in the area of risk management. I will get back to some of the things that we're doing along those lines specifically, but first, let's briefly cover the first-quarter results.

As shown in the financial highlights on slide 3 of the presentation, in the first quarter we earned core earnings per share of $0.46, $0.01 lower, so very consistent with the fourth-quarter core earnings. We are focused on keeping core income high while maintaining or improving book value.

In the first quarter, our book value was up $0.56 or 3% to $18.53. One way we look at value added for the quarter is adding the dividend we paid to the change per share in our book value. We paid a $0.50 per share dividend, generating economic value added of $1.06 per share in the first quarter or 5.9%, roughly, return on book value. That follows a book value gain of $0.33 and a dividend of $0.50, or $0.83 combined per share, or about 4.7% economic value added in the fourth quarter.

So far in the second quarter, with spreads improving further, book value is up another 2.5% to 3%, so we are on track for another strong quarter. We like the progress we have made, but we are focused on doing more to maintain or grow book value. I will cover what drove the book value improvement in the first quarter in a few minutes, but first, I mentioned things we are doing on the asset liability side and in risk management to improve stability.

On the asset side, our team remains committed to providing our shareholders with increasing exposure to three key strategies or initiatives, listed on the left of page 3. We find these to be the most attractive in the mortgage market, namely, participation in GSE risk transfer, CRE loans, and jumbo prime residential loans. Besides liking these assets from an earnings perspective, they enhance value stability by reducing interest rate risk, reducing our necessity for repo borrowings, and generally providing better matching of asset and liability cash flows.

In Q1, we invested $470 million across these three strategies, taking the total assets among the three to over $2.5 billion or 12%, roughly, of our assets. That is up from zero at the beginning of 2013. We continue to make progress on these initiatives in the present quarter.

On the liability side, we have also made progress. We are continuing to reduce short-term debt-to-equity leverage. Our repo leverage declined 0.2 turns to 5.5 times. And during the first quarter we reduced the repo borrowings by about $600 million. We also continued to diversify funding sources, adding several new counterparties, and setting up a captive insurance company that will be helpful to us in the future.

We reduced risk in several other ways. We reduced 30-year Agency mortgage-backed securities in favor of Agency ARMs and hybrid ARMs, thereby cutting interest rate risk, extension risk, and Agency spread risk. While our model equity duration or overall interest rate risk is targeted at 4 to 5 years, we have reduced the overall interest rate sensitivity to a point where empirically we're not seeing a correlation between our book value and the directional movement in interest rates. We are very well hedged from a rates perspective, and this shows up as significantly lower value at risk in our models and lower book value volatility empirically.

On slide 4, a few words on the investment environment. Economic indicators were generally softer than expectations in the first quarter, especially in January and February, as it was the coldest winter in North America in decades. Economists reduced estimates of US GDP growth for the year, even though many believe the weaker growth in the quarter was due to the climate as well as payback for inventory build in the fourth quarter of 2013. The economy to us seems neither too hot nor too cold, and inflation remains quite low, giving the Federal Reserve reason to stay on the current path of keeping rates low.

In the first quarter of 2014, market interest rates declined even though the Federal Reserve began tapering asset purchases. As I mentioned, we believe markets expected a more robust recovery coming into 2014, and those expectations were moderated in the first quarter. Similarly, markets' expectations for the pace of tightening once it starts were reduced.

Long rates therefore fell, but shorter rates were actually higher by little bit. Investor's push for yield intensified in this environment, and credit spreads -- that is, the additional yield above US Treasuries offered by non-U.S. Treasury securities -- fell. Declining credit spreads caused prices of CMBS and RMBS to increase more than similar-maturity Treasury securities.

At the same time, interest-rate volatility fell rather dramatically, reducing the value of options. Further, the supply of new mortgage loans was restrained by a lack of refinancing volumes and by relatively weak purchase mortgage volumes due to the harsh winter on top of already slow seasonal factors.

Given the lower supply of mortgage-backed securities, the Federal Reserve's reduced purchase volumes were still large relative to gross supply of newly issued MBS. Low volatility, tighter credit spreads, and favorable supply dynamics supported Agency mortgage prices. All things considered, the mortgage market environment was favorable for our Company in the first quarter.

Fundamental loan performance also continues to be favorable. Legacy residential loan performance continues to improve, with fewer delinquencies and diminished shadow inventory. We believe slower existing home sales numbers recently are due in large part to fewer distressed sales in addition to the weather. We believe house prices should be up about 5% this year, a more sustainable rate than the 13% in 2013.

On the commercial side, we continue to see higher prices, in part due to lower cap rates, but also due to better rent and net operating income growth. As a result, commercial property prices have recovered all but 6% of the fall from the peak prior to the crisis.

With that backdrop, please note the book value table on the left of page 5. With rates lower, our interest rate swap hedges offset much of the improvement in prices due to interest rates. Our hedges are largely meant to offset the rate risk in our Agency mortgage-backed securities and our CMBS buckets. Note that the combination of Agency mortgage-backed securities and CMBS were up $1.03, and our derivatives were up $0.84, so the difference of $0.19 represents improvement in yield premiums or credit spreads.

Also, the $0.33 per share rise in the RMBS bucket is largely the benefit of tighter credit spreads. The improved prices of Non-Agency RMBS and CMBS were the driving force behind our increase in book value by $0.56 per share. Modest share repurchases added a few cents as well.

Core earnings, on the other side of the page, were down $0.01, as I mentioned, due largely to our effort to reduce risk and volatility. Taxable earnings are running slightly higher than core at present, such that we estimate paying the $0.50 dividend is consistent with our current run rate on earnings.

We continue to focus on reducing interest cost and evolving the portfolio and liabilities to keep earnings strong. Our continuing efforts to improve book value performance and keep core earnings strong should be reflected in comprehensive income, and they are. Comprehensive income was strong in Q1 at $1.02 per share, as you can see on the right.

John Anzalone, our CFO (sic), will now talk about our investment strategy.

Thanks, Rich, and thanks again to everyone listening in. I'll start with slide 6 in the portfolio update.

As Rich talked about, we've continued to move the portfolio away from interest-rate risk and toward a greater exposure to an improving credit environment. The graph here provides a clear picture of our progress over the past several quarters, and that progress continued during Q1.

During the quarter we reduced our exposure to Agency fixed-rate collateral by approximately $0.5 billion, mainly through not reinvesting paydowns. The majority of those dollars were reallocated towards hybrid ARMs, where our balance increased by about $400 million. This resulted in shortening our duration profile, reduced extension risk, and made our portfolio easier to hedge.

On the credit side, we were active across a number of sectors, as Rich mentioned, adding exposure to our GSC credit risk transfer position, participating in another jumbo prime securitization, as well as adding to our positions in commercial real estate loans and CMBS. Going forward, we'll continue to add exposure to these areas.

Moving to slide 7 and Agencies, the bar chart on the right illustrates our move away from 30-year fixed-rate collateral and toward hybrid ARMs. The current environment, which has been characterized by very low prepayments speeds, which you can see in the graph on the lower right; limited supply; low volatility; and continued Fed purchases has been supportive to mortgage spreads. This has allowed us to reduce our exposure into strength. Over the next few quarters, we do expect the mortgage basis to struggle as the supply/demand dynamic shifts amid the slowdown in Fed purchases and the seasonal demand for mortgages increases off of multi-year lows.

As we stand now, we have reduced our equity allocated to Agencies by about 12.5% to 36.5%. Leverage on our Agencies was 10.9 times, but that was offset by lower credit leverage, bringing our overall leverage down from 7.3 times to 7 times. We also reduced our repo leverage from 5.7 times to 5.5 times.

Moving to slide 8 and Non-Agencies, as you can see on the bar chart on the right, our Non-Agency asset mix is evolving. Our re-REMIC book continues to pay down and now represents 35% of our exposure here. That exposure has been largely replaced by GSC credit risk transfer deals. We added $182 million during the quarter, bringing our total to $350 million at quarter end.

We also closed one jumbo prime deal during the quarter for $287 million, and net settled another one early in the second quarter. We took down leverage in this sector, moving through 3.5 times to 2.7 times, and our equity allocations in Non-Agencies now stands at about 44%. Performance in this sector has been very good, as spreads on the GSC credit risk transfer bonds continue to tighten, and legacy bond prices have been supported by good credit fundamentals.

Finally, moving to slide 9 and CMBS, our CMBS position increased slightly during the quarter. Our balance is up by about $70 million. The mix has been slowly evolving away from legacy paper, which is rolling down the curve, and towards new origination paper. We reduced our leverage here also, moving the leverage on CMBS to 3.1 times at 3/31, down from 3.6 times last quarter.

We were active during the quarter, taking advantage of positive market conditions to reduce subordinate exposure to underperforming retail assets. We also purchased subordinate bonds that have since benefited from further credit curve flattening.

That concludes our prepared remarks. Now we'll open up the line for questions.

(Operator Instructions) Trevor Cranston, JMP Securities.

Hi, thanks, and congratulations on a nice quarter. I guess, first, on the new initiatives, you guys have been pretty active in the GSC credit risk sharing deals, obviously, but it seems like spreads in that space have continuously ground tighter and tighter. Can you just comment on where you're seeing returns there now, and if your appetite for that asset class is still as high as it was during the first quarter, given where spreads stand today?

Trevor, this is John. I would say on the credit risk transfer deals -- I mean, obviously, you're right. They have had a fair amount of tightening over the past couple of quarters.

We're still finding ROE's in the very low double digits there, even at current spread levels. So it still looks attractive. We still like the credit profile.

I think we'll see going forward, as the GSCs look like they're going to expand the types of collateral they're going to include in those deals -- so maybe we'll see a little bit more opportunity for investing at slightly wider ROEs going forward. But as of right now, we're still pretty positive on that asset class.

Okay, that's helpful. On the commercial side, you guys added a little bit of commercial loan assets and some more CMBS this quarter. Can you maybe give us an update on just the pipeline for commercial loans? And also maybe talk a little bit about where in the capital stack you're investing in the CMBS space right now?

Sure. So we closed -- what -- one $23 million preferred equity position in the quarter. The pipeline -- we always have a number of deals we are working on. It is a competitive space, and some of them through diligence fall out, and some of them we are outbid on. But we are still pretty optimistic in the space that we continue to make progress.

It's lumpy, so it's hard to say that we think we'll get X amount done. But I'd still estimate two or three deals a quarter is what we're shooting for. Again, the average deal is generally around $20 million, if that gives you a good idea.

And we'll continue to focus dollars in the space. Right now I think we have a term sheet for deal that's a $40 million. So hopefully that will work out. And we are working on our portfolio of loans. We also think there could be some opportunities in Europe. So we're optimistic going forward, and we're excited about the space.

Yes, on the CMBS side, we're still -- on the newer origination paper, we're still playing in that -- call it, on average, a single-A space.

Got it, okay. And then I guess last thing -- obviously credit spreads, it looks like, were the primary driver of book value in the first quarter. And from everything we've seen, it looks like spreads have continued to tighten so far in the second quarter. Can you maybe give an update directionally on the impact that's had on your book value so far in the second quarter?

On credit spreads overall? On our book value?

Yes.

I think Rich mentioned on the call -- as of this weekend, it was up about between 2.5% and 3%.

Oh, sorry, I missed that. Okay, great. Thank you.

Doug Harter, Credit Suisse.

Thanks. You guys mentioned that you were looking to improve your funding costs and restructure some of the liabilities. Give a little more detail about that.

Sure. So I mean we've continued to increase counterparties. We also set up a captive insurance company, and our goal is to provide capital to the US residential and commercial mortgage market. Then this is in line with the Federal Home Loan Banks' mission to provide low-cost financing to member institutions.

And so we have -- our captive insurance company is a member of the Home Loan Banks, and we do think that we can finance through that captive insurance company mission-related assets. And that would be things like CMBS space, higher-rated CMBS, new issue residential loans, and commercial mortgage loans.

Great. I appreciate the color there. Thanks, Rich.

Nick Agarwal, Wells Fargo.

To piggyback on the HPA part, I guess you guys are talking about their being roughly low to mid-single digits. And with tighter credit spreads, how much do you guys think that the lower HPA environment is reflected in the current Non-Agency bond pricing?

I think it might be a little bit disappointing to the subprime market, which we're really not involved in. For higher quality assets, slow and steady increases in prices is kind of the best environment. So I think in the legacy space, generally, there's just fewer and fewer bonds around. And so the technicals are quite strong, definitely more buyers than sellers.

It doesn't feel like there is much risk of any significant widening. And I think it would take house prices going down again to cause any pickup in that market.

Okay. And then next, are you going to be -- I know you don't really own this asset class so much, but are you going to be looking at the HUD SFLS sale coming up in June? Is that something of interest?

We haven't focused on that. We may.

And then lastly, your Q2 resi securitizations -- will that be roughly the same size as the one you did in Q1?

Yes, it's in the ballpark.

All right, thanks, guys. And Don, good luck to you.

Dan Altscher, FBR.

I was wondering, as you migrate the portfolio to less rate sensitive on the Agency side -- you know, clearly the pickup in hybrid ARMs is there, but is that pool getting harder and harder to find? And why not try to go more into the 15-year side, as well, as there might be some similar duration there, maybe on some of the longer-term hybrid ARMs?

Right, so -- right. That's exactly -- when we, generally speaking, look at 15s and hybrids, we choose between those in terms of a relative value call. And lately, we just like hybrids a little bit better.

On the supply side, I'd say -- yes, it's hard to put a ton of money to work in hybrids. It is a very limited supply right now. But the good news is we're not -- we're migrating the portfolio. We're not trying to -- we don't need to put enormous amounts of money to work in that space.

So as we've been not reinvesting paydowns or reinvesting paydowns out of 30-year fixed into hybrids, there's been enough supply for that. So, I mean, that's kind of where we have been going. So I think that's kind of the answer.

Because we're reducing agencies overall, so the whole book is (multiple speakers) a little bit.

Okay. On the new captive insurance subsidiary, are you guys formally now a member of the FHLBR or have access there? And can you also maybe describe how that process went in terms of -- if you're not, or if you're in process, how that process is going? How thorough is FHLB to take on exposure from mortgage re? Or maybe just give us a feel of how that's going?

So just to be clear, our insurance subsidiary is a member. The mortgage REIT is not.

And as of right now, we have moved our assets down to the subsidiary and financed in the AA CMBS space. And we'll continue to grow advances in line with the mission of the FHLBI and in line with our mission.

Okay. And I assume, then, for the FHLB to -- for the insurance company to exist, there has to be an insurance product that is provided. Can you just talk what that is, actually?

Hey, Dan, this is Don. We don't want to get into details of that. Basically, it's a captive insurance, and organized and licensed as it should be, and meets all the requirements to be a member. And we're very excited about the opportunity.

Okay. And finally, just one quick one. There's no taxable implications, like I think one of your peers has? Like, they don't have a tax issue with insurance sub?

No, there's no tax issues with an insurance subsidiary. Again, it's all in how you structure it. I think the way people should be looking at this is it's a great counterparty; it's a great source of funding. And we think it meets the mission of the Federal Home Loan Bank. And they do, as well. Our goal is to basically, again, continue to reduce funding costs for the Company and improve our liquidity position. And we think this really helps.

Thanks so much.

(Operator Instructions) Dan Furtado, Jefferies.

Apologize if you hit this already, but I'm just looking for yields and/or expected IRRs on the recent jumbo securitizations, how they have -- maybe not absolute levels if you're uncomfortable there, but how they have changed over the past 90 days; if you're seeing any movement on credit enhancement levels or discussions with the rating agencies as well? Thank you.

Nothing has changed dramatically recently. Volumes are definitely low in the loan space as far as trading volumes. But in terms of our ROEs, we're still looking in the double digit -- call it 11%, 12% ROE.

Understood. Okay, great, thank you for the commentary.

Thank you, and at this time, I'm showing no further questions.

Excellent. Okay, well, thank you. Let me close by saying, we're very excited about where we are and the positive direction we're heading. We want to thank everybody for listening today.

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for joining.