Invesco Mortgage Capital Inc (IVR) 2014 Q3 法說會逐字稿

This presentation and comments made in the associated conference call today may include forward-looking statements. Words such as believes, expects, anticipates, intends, plans, estimates, projects, forecasts and future 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.

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Good morning, ladies and gentlemen. Welcome to the Invesco Mortgage Capital, Inc.'s Investor Conference Call. 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'd like to turn the call over to the speakers for today, Richard King, Chief Executive Officer; John Anzalone, Chief Investment Officer, and Lee Phegley, Chief Financial Officer.

Mr. King, you may now begin.

Good morning everybody and welcome to the third quarter 2014 Invesco Mortgage Capital earnings call. Our management team believes we can deliver optimal shareholder value over the long-term by producing a high level of current income to shareholders, generated through core earnings and passed along in the form of dividends. We believe we can deliver book value stability over the long run by managing risk appropriately. We very much like the way we're positioned now, having spent 2013 and 2014 advancing our strategic objectives, repositioning the Company toward credit and away from interest rate risk.

As shown in the financial highlights on slide three of the presentation, in the third quarter, we earned core earnings per share of $0.44. Over the last three quarters, we've reported core earnings of $0.46 in the first quarter, $0.50 in the second quarter and $0.44 now in the third quarter. The third quarter was on the lower end of our core earnings run rate due to factors such as temporarily higher [prepay] rates in the summer and some drag from things that should improve earnings in the long run like moving assets off of repo so that we could collateralize advances and investing the proceeds of the preferred offering.

We currently see core running in the middle of the $0.44 and $0.50 range and we've reduced risk as well. Our leverage is lower, our interest rate risk is lower as a result of our asset strategy and funding strategy, both of which are much more balanced. As a result, our book value volatility has been reduced a great deal and our earnings should be more stable going forward. In the second (sic) quarter, our book value was down $0.64 per share or about 3% to $19.16 per share. That was due to spread softness primarily in July and August (inaudible) three quarters of strong book value growth from spread tightening. And as a result, book value per share is still up 6.6% year-to-date and we've generated comprehensive income year-to-date of $2.67 per share and an economic return on book value, that is dividends plus book value growth, year-to-date through the third quarter, up nearly 15%. We also made significantly more progress in our strategic objectives on the asset and liability sides of the balance sheet.

In the table at the bottom of page three, we highlight the shift we've made in our assets. Over the last six quarters, we've reduced our 30-year agency MBS from well over half of our assets to less than a quarter. Total agency mortgages, including hybrids and 15 years, now only 37% of our equity capital allocation and most of that is shorter-duration MBS. Much of the freed up capital has been redeployed into loan strategies and agency hybrids. We've maintained momentum putting capital into GSE, CRT and commercial real estate mez and also participating in new loan securitizations.

On page four, let's take a couple minutes to look at the investment environment in the third quarter. Financial conditions tightened on the margin in the quarter as some market participants believe that fed could be embarking on a tightening cycle at the time as soon as the first quarter of 2015, we thought some softer credit spreads and slightly higher interest rate volatility. Stepping back and looking at the big picture, however, economic and financial conditions remain favorable for our business. We took advantage of the lighting in CMBS and CRT spread by issuing preferred stock and using the proceeds to add assets at more favorable ROEs than we've seen all year.

Meanwhile, inflation is showing no signs of increasing. In fact fears of global deflation seem more pronounced and the stronger dollar and relatively higher rates here in the US are attractive to global investors. Fundamentals are steady in both residential real estate and commercial real estate. We expect credit spreads to continue to grind tighter. Meanwhile, our book value has shown little or no correlation to the direction of interest rates. Our hedges are working well. Quarter-to-date, our book value is about unchanged in the current quarter.

The interest rate risk we run is much lower from where it was last year or any time prior. We like where we're positioned and the book value stability that the positioning provides. We've increased our capabilities across mortgage markets. We have ample opportunities to deploy capital to the best opportunities whether that is in commercial real estate loans, residential loan packages, CMBS, legacy RMBS, credit risk transfer or agency MBS.

Let's turn to page five and look at the liability side of the balance sheet. We've been hard at work in 2013 and 2014 to diversify funding sources. In the top panel of page six, you can see that we continue to find new ways to fund asset purchases. We've issued corporate notes using securitization financing, our insurance sub has utilized secured advances. In the third quarter, we entered into an additional $625 million of home order advances, bringing the total to $1.25 billion of floating rate advances and they all have a 10-year term. This significantly extended our overall average maturity profile.

Securitization financing is also growing each quarter. And at quarter end, we have over $2.7 billion of match-funded non-recourse asset-backed financing on the balance sheet. Over the last six quarters, we've gone from substantially all of our liabilities being short-term repo, like most of the industry, to now under three quarters. Our repo balances have declined by about $4.3 billion over the past six quarters. Significant diversification in our funding makes us much less reliant on repo financing. We have several ways of investing without need for repo and we have significant capacity to increase our funding.

On page six, we display a roll forward of book value in Q3. In the agency portfolio, our average 30-year mortgage fixed rate coupon is 4.3% and 15-year average coupon is over 4%. In the third quarter, higher seasonal prepayment speeds caused dollar prices on our higher coupon portfolio to decline a bit. Higher speeds is not a trend, we do not expect speeds to increase further. In fact, we expect prepaid speeds to decline in the fourth quarter and we expect (inaudible) coupon to perform very well in a rising interest rate environment.

High coupon mortgages have exhibited very little duration. In credit bucket, CRT spreads widened and CMBS spreads widened in the last quarter causing most of them be a modest book value decline. There was a spike in issuance over the summer in those two spaces, but again we do not see a trend to wider spreads, rather we expect spreads to grind tighter for higher quality assets like we own. Our derivatives book improved due to higher rates offsetting the asset declines associated with rate changes.

We are left with modestly lower book value as a result of the credit spread widening. Again, we are not concerned. Nothing about the decline is permanent, it's a small move down in the context of a broader improvement and we like the opportunity that wider spreads gave us to invest. On the right, you can see two measures of earnings; we came in on the lower side of core earnings with respect to recent quarters at $0.44 as I mentioned earlier and comprehensive income was slightly negative given the modest book value decline. The factors that drove the third quarter earnings per share somewhat lower are listed on the bottom right of the page.

In addition to higher speeds, we did have some drag from moving assets off of repo and we also had some drag investing the proceeds as a preferred stock deal. But that is one quarter, year-to-date core earnings of $1.41 per share over three quarters probably gives a better indication of run rate and year-to-date comprehensive income has been strong at $2.68 per share, given our stronger book value year-to-date. We anticipate an environment characterized by low yields and low spread volatility to persist for the remainder of the year and well into 2015.

I'll now turn it over to John Anzalone, our CIO to talk about our investment strategy.

Thanks Rich and thanks again to everyone joining us on the call today. I'll start on slide seven with the portfolio update. As you can see in this chart, we continue to make great progress towards our goal of reducing IVR's exposure to interest rate risk and increasing our exposure to high-quality credit. In fact, agencies now make up less than 50% of our total assets and our exposure to longer-duration lower-coupon agencies is under 12%. While wider spreads on credit have negatively impacted book value, the flip side is the spread volatility creates buying opportunities.

We took advantage of those opportunities by increasing our exposure to legacy non-agencies, credit risk transfer bonds and senior classes of CMBS. We closed two more jumbo prime securitizations during the quarter and expect to close two more in the fourth quarter. We also closed two more CRE loans during the third quarter and expect to make additional investments in that space during the fourth quarter. These moves have left us with a very manageable interest rate exposure with our duration gap in the half-year range, while the empirical duration has been very close to zero.

Over the course of the past few quarters, our book value has shown almost no correlation to rates. With fundamentals continuing to look at in both the residential and commercial spaces, we very much to (inaudible) money to work in new issued well-underwritten credit assets.

Let's take a closer look at each sector, starting with agencies on slide eight. The bar chart on the upper right of slide eight gives a very good depiction of the evolution of our agency book. Hybrid ARMs now make up nearly a third of the book, up from less than 10% a year ago. Less than a quarter of our agencies are in lower-coupons defined as 4s and under and average coupon of our 30-year collateral is 4.3%. We are similarly up in coupon in 15-year agencies where the average coupon is just over 4%. Our fixed rating agency portfolio is a well-seasoned, higher-coupon specified-pull portfolio that should be well insulated from any increase in prepayments that might occur due to the recent drop in rates. Even if we do see some pick up in refinancing activity, we expect that winter seasonals will kick in and that the overall prepayment environment will remain benign. Our outlook for agency spread is also benign as we see relatively tight valuations balanced by a favorable supply-demand picture.

Let's move to slide nine and residential credit. Between non-agency bonds, credit risk transfer and residential loans, residential credit now makes up 34% of our assets, up from about a quarter of our assets a year ago. This quarter, we took advantage of wider spreads in the re-performing market by adding well-enhanced short cash flows to the portfolio. The two jumbo prime securitizations added $847 million of loans to our portfolio during the quarter. We expect to close two more in the fourth quarter. Performance here remains stellar with still no loans 60 or more days delinquent. Finally, in GSE risk transfer bonds, we took advantage of the recent spread volatility in that space by continuing to add to our position. Our exposure to those bonds increased by just over $100 million during the quarter. While these bonds have experienced a fair amount of spread volatility lately. We're still very comfortable with the underlying credit fundamentals and the cash flow ROE remains very attractive.

Finally, let's take a look at commercial credit on slide 10. We continued to increase our CMBS position during the quarter, adding over $400 million in high quality AA and AAA bonds that were financed by Federal Home Loan Bank through our captive insurance subsidiary. These purchases serve to increase the overall average credit quality of our CMBS holdings. In fact, since March we had repurchased over $1 billion in new issued AA and AAAs and these now represent over 25% of our CMBS holdings. Additionally, we closed a pair of commercial real estate loans totaling $48 million, including our first cross-border transaction. As of quarter end, our holdings in CRE loans, mezzanine certificates and joint venture interests totaled $235 million. With commercial real estate fundamentals remaining favorable, we expect moderate and opportunistic growth in CRE lending.

That brings us to the end of our prepared remarks, please open the floor for questions.

(Operator Instructions).

Operator do you have any questions in the queue?

Vic Agarwal, Wells Fargo.

You guys have done a good job shifting the investment portfolio more towards the credit side. As we continue to see slower HPA, I was curious on your thoughts if we continue to see that occurred and if we went to zero or negative, how would you sort of -- what would be sort of your philosophy towards that asset class?

First of all, just on home prices. We've been saying all year long that we expected the year-over-year rate to be 5% this year and that's about where we are. And we really believe that home prices are going to continue to increase in mid single-digit kind of range. There really aren't conditions existing that would drive home prices lower, there's not an over-supply of homes, affordability is high. There's still some positive momentum in prices. Having said that, I mean we have obviously a great deal of flexibility in terms of our portfolio and our ability to move assets around and if we believed home prices were going to fall, we certainly would reduce holdings in mortgage credit.

I'd add, I mean the quality of the underwriting that's happening right now is extremely high. So, I mean, even if we saw a modest decline in HPA, I think we're pretty comfortable that the collateral will hold up against not like it was in 2006 or 2005 or something like that.

And then I think in the past you had targeted about 25% of your equity capital in your various silo strategies. Can you give me sense of where you are in the equity allocation?

I would say we -- target might be a little too strong of a word. We kind of put some upper limits on where are we going in various sectors, especially the newer initiatives, but we're very happy with where the portfolio is positioned. The point was to find the best risk-adjusted returns. I think we believe we're positioned very well. We continue to look for opportunities in CRE loans in the risk-sharing space and securitization of single-family residential non-agency. We don't have absolute targets, we're really just deploying capital where we see the best opportunities. At present, we've recently seen the best opportunities in the CMBS space and then GSE CRT space.

Lastly, I saw that you mentioned that you did two jumbo transactions, I think that was up from one and size seems to be increasing. Is that sort of the size you did in the third quarter what you expect in the fourth quarter and then also what you think is driving the increase, is the spreads better or the banks pull back a little bit? Can you give me a sense of what's happening there?

In the third quarter, we did consolidate two deals. We expect to participate in two deals in the fourth quarter as well and close two. The spreads in that market widened out a bit, especially on 30-year collateral maybe half a point. So, that may slow things down a little bit, because you did have all throughout 2014 spreads on non-agency or tightening versus agency. In the hybrid space where we've done our more recent deals, we really haven't seen much change in pricing.

And then the size you're expecting roughly the same size of the third quarter or is that more along the size of the second quarter?

I think it's about the same size.

It's in the ballpark.

Douglas Harter, Credit Suisse.

This is Matt Freedman calling in for Doug Harter. I was wondering if the capital from the preferred stock has been fully redeployed.

Yes.

(Operator Instructions) So, no further questions.

Okay Operator. We'll stop there. I just want to thank everybody for listening today.

That concludes today's conference. Please disconnect at this time.