Invesco Mortgage Capital Inc (IVR) 2015 Q1 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to Invesco Mortgage Capital Inc.'s First Quarter 2015 Investor Conference Call. 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 to call over to Tony Semak in Investor Relations. Mr. Semak, you may begin the call.

Thank you, Dexter. And good morning, everyone. Again, we want welcome you to the Invesco Mortgage Capital First Quarter 2015 Earnings Call. I'm Tony Semak with Investor Relations, and our management team and I are really delighted you joined us today as we look forward to sharing with you our prepared remarks during the next several minutes before we conclude with a question and answer session.

Joining me today are Rich King, Chief Executive Officer; Lee Phegley, Chief Financial Officer; John Anzalone, Chief Investment Officer; and Rob Kuster, Chief Operating Officer.

Before we begin, I'll provide some customary forward-looking statements, disclosures and then we'll proceed to management's remarks. Comments made in this conference call and related press release and presentation may include statements and information that constitute forward-looking statements within the meaning of the US securities laws as defined in the Private Securities Litigation Reform Act of 1995, and such statements are intended to be covered by the safe harbor provided by the same. Forward-looking statements include our views on the risk positioning of our portfolio, domestic and global market conditions including the residential and commercial real estate market, the market for our target assets, mortgage reform programs, our financial performance, including our core earnings, economic return, comprehensive income and changes in our book value, our ability to continue performance trends, the stability of portfolio yields, interest rates, credit spreads, prepayment trends, financing sources, cost of funds, and our leverage and equity allocation. 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.

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 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. We expressly disclaim any obligation to update the information in any public disclosure if any forward-looking statement later turns out to be inaccurate.

An achieve of this presentation will be available on our website and a telephone recording can be accessed through May 21 by dialing 888-562-2797 or for international callers 1-203-369-3747. To view the slide presentation today, you may access our website at InvescoMortgageCapital.com and click on the Q1 2015 earnings presentation link you can find under the Investor Relations tab at the top of our homepage.

There, you may select either the presentation or the webcast option for both the presentation slides and the audio. Again, welcome and thank you so much for joining us today. We will now hear from our Chief Executive Officer, Rich King. Rich?

Thanks, Tony. Good morning everybody and welcome to the first quarter IVR earnings call. In the first quarter, we're pleased to report core earnings of $0.50 per share. We paid $0.45 dividend. Our book value grew $0.55 per share to $19.37 per share or an increase of nearly 3%. Combining the dividend we paid and the increase in book value, our economic return for the quarter was 5.3%.

We remain well-balanced across commercial, residential and agency and have had success modulating risk exposures as we find new sources of value across mortgage markets. In the first quarter, we added value in a number of ways. Equity allocations, target assets and positioning along yield curve added value, but asset selection, earning the right assets within these allocations was the real driver. We are also seeing benefits of investments we made in distressed commercial real estate several years ago. This JV interests which we co-manage with investor real estate and WL Ross added $0.05 to Q1 earnings.

These investments are small component of our equity and assets that we expect the contribution to earnings to be positive, but not at this magnitude. Our book value at $19.37 per share has been on an upward trajectory for the last three and a half years, and has had little correlation with rates over that period.

We hedge the preponderance of the interest rate duration of our assets, such that we remain largely neutral to the overall direction of interest rates and primarily earn income through prudent exposure to spread risk.

On page four, we present a roll forward of our book value on the left. And here, let me explain why our book value grew $0.55 in the quarter.

First, we were well positioned from a sector standpoint as commercial and residential markets performed better than the agency MBS market broadly in Q1. We use hedging to actively shift our net key rate duration exposures, because that is more efficient than trading assets to shift curve position. Our hedges were positioned such that we benefited from the yield curve upon this amount. Within each of agency MBS, residential credit and commercial credit, asset selection-based valuations. In the agency MBS allocation, selection was quite positive. We own longer hybrids, 15-year fixed and specify up in coupon 30 years, all of which outperformed the broad MBS market.

Agency MBS on a gross basis before hedging contributed $0.59 to our overall increase in book value as shown in the bar chart. Within the residential non-agency allocation, selection was positive as the credit risk transfer and re-performing loan securities that we own appreciated while the larger part of the market, the legacy RMBS, were close to flat in price. So this sector added about $0.13 to book value and there's no associated hedging costs there.

Within the commercial allocation, CMBS 2.0 performed quite well and the season subordinates we have did better still. CMBS valuations added $0.40 gross of hedging costs. Rates were lower in the quarter, so our hedges, derivatives in the bar chart, lost $0.60 in value, but the agency CMBS components combined for $0.99 outperforming the rate hedges by $0.39 for the quarter.

On the right, we show two measures of income. Core is a non-GAAP measure, which we define, unlike GAAP, excludes changes in the valuations of our hedges. And of course both don't include changes in our asset values. So we believe this is a more stable and consistent measure of earnings. We earned $0.49 of core in Q4 and $0.50 in Q1. But keep in mind both quarters benefited from low prepayments and significant income from the JVs. The JVs added $0.05 as I said in Q1. We expect faster prepay speeds in the second quarter and we anticipate that will have a negative impact on core in Q2. But with the recent backup in rates, we expect prepayments speeds to peak in April-May, and then slow down. We have no assurance that the JVs, which added the $0.05 to earnings in Q1, will be accretive to earnings going forward. As I said, we expect some contribution.

Comprehensive income also shown as a GAAP measure, includes the changes and valuations of assets and liabilities and earnings, making it a more volatile earnings number than core. It is generally similar in size to economic return. Comprehensive income was $0.12 for Q4 and $1 per share for Q1. Over the long run, we expect core of comprehensive income to average out, but quarterly be more stable.

On page five, you can see as I said before that our allocation of equity is balanced in the first quarter. This is consistent with where it was in the fourth quarter of 2014. We believe this allocation aligns shareholder outcomes with strong underwriting and economic fundamentals in both residential and commercial real estate. At the same time and provides the safety and liquidity of agency MBS and we balance it with hedges that we believe are fair market value, large uncorrelated to interest rates.

The table below is meant to give you a better sense of how the mortgage market is not monolithic that really matters what you are within the market. This is the data from widely recognized indices Barclays Capital. To illustrate that selected sectors outperform the broader market and giving IVR's book value some lift. The mortgage index is dominated by 30 years and specifically mortgages with coupons less than reported 4%. John will show that we own very little of that.

On the table, we show the 30 year fixed-rate return, a negative 51 basis points excess return. So said another way, if you bought that index and hedge with treasuries, you would have had a negative 0.5% economic return. We have been adding longer hybrid ARMs and CMBS over the last couple of years and you can see here that they continue to perform very well in the first quarter.

I will leave more detail to John to talk about in our portfolio, but I like the fact that we have a very high quality season credit portfolio. It has embedded appreciation in the underlying loans and the assets we earn are shortening and rolling down the curve as current assets that are performing well are fundamentally shorten with the passage of time. And market yield investors are willing to accept if it gets lower due to both the yield curve and the credit component and this has been significant wind at our back.

Before I turn the call to John, a quick update on our outlook. The underpinnings of commercial and residential real estate credit are favorable. Employment is growing, rents are growing, occupancy is growing as well. Prices of homes have settled into what we expect to be a 3% to 5% annual improvement, a healthy and sustainable rate, which we believe is attractive for prospective buyers and home buyers as well. Credit underwriting in residential remains restrictive and the performance of loans reflects that. Agency conforming and prime jumbo loans have very, very little serious delinquencies. We expect credit premiums to continue to contract due to the fundamentals and owing to negative net supply generally.

John Anzalone, our CIO will now discuss our investment strategy in more detail.

Thanks Rich, and thanks to everyone who's dialed in this morning. As Rich has discussed, the portfolio performed as expected during a fairly volatile interest rate environment. As we've discussed over the past year, we've been rotating away from interest rate risk and towards credit risk, and the portfolio saw the benefits of this active management this quarter. We believe this spread in both credit and agency will be supported as investors continue to hunt for attractive yields.

Starting on slide eight, I'll walk through the different parts of the portfolio. Here you can see that we have our equity allocated about equally between agencies, residential credit and commercial credit, roughly unchanged since year-end. This gives us a highly diversified portfolio with a mix of residential and commercial exposure, government guarantee and private label as well as a combination of legacy securities in newly underwritten credits. 66% of our equity is allocated to credit strategies where fundamentals are continuing to improve. This allocation has significantly reduced our interest rate risk as the empirical duration of our equity has been hovering around zero, meaning that our book value has not been meaningfully impacted by changes in interest rates and that was certainly evident this past quarter.

This outcome aligns with our strategy of generating earnings in credit spreads and leveraging the company to improving credit fundamentals. In fact, this is just a scenario that we saw during the first quarter with increased rate volatility and tightening credit spreads.

Next, I'll go through each sector and outline how we are positioned to take advantage of the current environment. We'll start with agency mortgages on slide nine. While we've made a deliberate move towards credit assets over the last year, we still have one-third of our equity and about half of our assets dedicated to agency mortgages. We really like how our agency portfolios position with respect to interest rate and convexity risk. By actively increasing our allocation to 15-year collateral and hybrid ARMs, the portfolio significantly outperformed lower coupon 30-year collateral. In 30 years, we continue to focus on higher coupon-specified pool paper, the average coupon of our 30s is 4.3% and consistent with a variety of prepayment protected collateral storage as you see in the pie chart breakout.

Prepayments remained contained with CPRs in the low-to-mid teens. And while we saw a small increase in April due to seasonal factors, speeds moderated in May and we expect that prepayment should continue to subside as rates have risen to the top of the recent range. One thing that I want to point out is that while we have been focused on reducing the interest rate and convexity risk of our agency book, we are still positive on agency spreads. We certainly like having half of our assets in extremely liquid bonds intend to performed well in stressed market conditions. Given the significant yield advantage that agency mortgages have over most competing assets and certainly over other global bonds with government backing, we feel that mortgage spreads are going to be well supported in the near term.

Let's move on to the residential credit book on slide 10. Over the course of the quarter, we consolidated one additional securitization that recently originate in prime jumbo loans. Otherwise, we did not make any material changes in the residential credit portfolio as we continue to like the composition of the book. We are well diversified with the resi credit, with exposures to both collateral, which is benefiting from improving housing fundamentals as well as newly underwritten collateral, which benefits not only from an improving housing market, but from strong underwriting.

We saw a modest tightening in spreads on our legacy book reflecting not only the improving fundamentals, but also the strong demand for shorter duration spread assets. Looking at our newly underwritten collateral, these positions benefit from strong borrower and collateral performance. Of particular note, our GSE credit risk transfer bonds experience significant tightening over the quarter, has not only this collateral performance was very good, but investor demand continues to be very strong for new issue deals and the investor base in this asset class continues to grow. Another clear positive for our resi credit book is that these positions have very little interest rate exposure and therefore should be well insulated from any potential volatility and rates.

Moving to slide 11 and commercial credit. As Rich discussed in earlier, we really benefited from superior security selection in CMBS. Credit spreads in our season CMBS 2.0 position tightened modestly while the tightening in our season subordinate bonds was more significant. The starting preferred credit is very similar to the story in residential credit, an improving fundamental picture continues to support both CMBS and CRE investments, and the demand for high quality credit assets remains extremely strong. Within our commercial book, we also benefit from the diversity of our collateral with a mix of legacy and new issue bonds as well as a combination of AAAs and subordinates.

Our legacy positions are short duration on average revenue per year and newer production bonds have bullet-like maturities and are therefore easily hedged. Again, this hedged portfolio has little interest rate risk and is positioned to take advantage of strengthening fundamentals.

On slide 12, I want to talk briefly about our efforts on the financing side. Just as we have the most highly diverse asset mix amongst our peers, we believe that diversifying on the financing side is equally important. To this end, we now have a combination of repo, preferred stock, convertible notes, securitizations and Federal Home Loan Bank advances. During the quarter, our cap has increased its borrowing to the home loan bank by $300 million and we completed our first direct repo transaction. Repo funding now represents 71% of our financing, down from 100% a few years ago.

So, let me turn it over to Rich to wrap up.

Thanks, John. In closing, I'd like to make three points. First, we like the way we're positioned in this environment, the assets we own and the lack of correlation we are seeing with rates. Second, we've been focused on stable attractive income and growing or keeping stable our book value and we've delivered with a strong start to the year and favorable results over the last year in three years. And then finally and probably most importantly, it's our discipline that can sustain these strong performance numbers. We've leveraged the platform to find value, values like the JVs that we invested in several years ago or the $50 million mezzanine we just closed on with the help of our real estate team.

Our credit team does phenomenal work. We protect capital, have no other than temporary impairments and then the crisis this team kept Invesco out of harm's way. We modulate exposures and do it well, and that shows up in our team across the board, top quartile performance. We're disciplined about hedging interest rate risk taking credit for spread risk, and we're disciplined about risk management. Liquidity continuing to improve funding sources. We've made significant changes and progress there. I can say without question I'm very proud of what this team has done and really like being a stockholder of this company.

Operator, let's open up for question and answer.

(Operator Instructions) Dan Altscher, FBR Capital Market.

Good morning. This is actually Cole Allen on for Dan Altscher. Thanks for taking my questions. So I guess to start off, you guys have a really, really good book number and you talked about it a lot on this call. And I guess, I just want to get a little update on how we're tracking through 2Q? And then secondly, you said prepayments ticked up a little bit in April. Is that kind of actually going to be like a blessing in disguise as rates have kind of spiked since then and you can maybe redeploy capital quicker to your credit strategy or what's your thoughts on that?

So first of all, on the progress in the second quarter. Again, in terms of book value, it's not materially changed from where we were at the end of the first quarter. On the prepayments, I think, I'd just reiterate that we have up in coupon agency book obviously. It's great because it's short duration, but it is impacted by faster prepayment. So, the numbers in April would cause core earnings to be down a little bit that, you're right, we kind of welcome a rise in rates and the pickup in prepays that we was in April were associated with rates 50 basis points lower or more than that from where we are now. So, yes, I think it's kind of a temporary and we welcome the better reinvestment rates.

Right. And I referenced May speed. So we had this prepayment report came out last night that showed speeds moderating a bit from April. So we expect that to continue through the next several months. And even with higher rates, you are going to get seasonal factors even if rates hadn't gone up, you would expect prepays to moderate a bit, but certainly higher rates are helpful for the agency book.

And then I guess one more question. You guys have been investing a couple quarters now and a lot of your peers are starting to get bigger into it, but the GSE credit risk transfers, I guess, what is you guys' current outlook on those? Are those may be one of the best uses of capital out there for you guys, or if not where are you seeing the best opportunities?

No, I think that remains one of our best opportunities from an ROE perspective. I mean spreads albeit tightened quite a bit, are still call it for unrated bonds in the 375 to 400 range depending on the bond. So, we still like that and in fact one of the issues that I think that market has had is been a limited investor base and seeing more of our peers and more of other investors become interested in the stories only been helpful for spreads. For us, the way we look at, the more liquid this market gets and the bigger the investor base grows, it's better for our holdings.

(Operator Instructions) Steve DeLaney, JMP Securities.

Thank you. Good morning, everyone. Pleased to be on with you on coverage perhaps this morning. Two of us want to congratulate you guys on what we think is the best performance in the first quarter among any of the residential mortgage REITs. So great job to start the year. Rich, I would like to start with this $50 million mezz loan that you announced on April, 29 in a separate release on the Atlanta building. I just wondered if you could talk a little bit more about your LTV attachment points, maybe on this loan specifically, but also kind of where you see yourself sort of in the capital stack generally on this product and maybe if you could talk about the yield on this relative to the 8.5% average yield that you have on your CRE loan book so far? Thanks.

Steve, this is Rich. I think in terms of our disclosure on that particular loan, I'll get back on how much we're going to disclose about each loan, but broadly we were very comfortable with the investment. We think it is class A quality investment. The return is in line with what we've done. We expect something like 8.5% high RR on this investment.

Okay. And those are -- I think that level, those are floaters generally what two-year to three-year kind of initial term, so the rate kind of reflects the duration, right?

That's correct. (multiple speakers) duration is floating rate.

Yes, exactly. So even better, right. As we look at the portfolio, this seems CRE credit seems to be where you guys are trying to reallocate capital. You are continuing to sort of rotate within resi credit too, but the growth has been the 34% now. Where might that go over the next year or so? And should we expect the actual whole loan portfolio to increase relative to the CMBS 2.0 positions?

Well, I think in terms of the overall mix, we're happy with the balance that we have right now and I think broadly people always underestimate the agency market. If you look back over time, Steve, and look at the risk adjusted returns in agency space, it's pretty dramatic how strong it is. It just continues to deliver. I think people always kind of overestimate the prepayment sensitivity and the efficiency of borrowers and so forth. So we're not really looking to continue to reduce that. I think a third of our equity is where we want to be. In terms of the commercial, we are focused on continuing to originate CRE loans, but we are very, very credit sensitive and do a lot of work on each one. And so it's a little bit difficult to predict how much of that can grow.

I would say the loan growth is likely to come from our legacy books that are starting to pay down, both in legacy and in agency, there in CMBS and in residential. So, that's where we'd likely see a shift in assets. Because the CMBS is book obviously is from 2005 through 2007, so those (inaudible) on the resi side same thing, it's 2005, 2006, 2007 production.

Okay. That's helpful. I appreciate it.

We do see some interesting things in the pipeline, and on the series side.

Yes. We'll stay tuned and keep an eye out for those as you announce them. Just one final thing on your home loan bank membership. Remind me whether you're in Indianapolis or Des Moines, I can't recall.

We are in Indianapolis.

Indianapolis, okay. And the $1.55 billion that you're up to now, how much additional capacity do you have with your relationship with Indi?

Another $950 million. About $2.5 million in total.

$2.5 million total, alright excellent. And it looks like mostly CMBS posted currently. Just curious whether you're looking at any other possible asset pipes to pledge to the Federal Home Loan Bank? That's my last question, thanks.

We've used some agency CMO as well, Steve, against that. We would probably look to grow that against agencies as opposed to more credit.

Okay. Would I be right to assume that there's no way that a CRE mezz loan is going to be eligible at the FHLB assuming you want to do just very modest leverage?

That's correct.

Charles Nabhan, Wells Fargo.

Thanks, good morning guys. I was wondering if you could comment on the BP space and if that's an area that you would potentially be interested in within your CRE allocation and I guess looking ahead, when you think about Dodd-Frank risk retention requirements upcoming, if you see that as a potential opportunity within that investment set?

Yes, the BP space is something we look at in addition to home loans and bank loans in the CRE space. The second part of the question on Dodd-Frank, I'm sorry, could you repeat that?

Yes, I was just hoping you'd comment on Dodd-Frank risk retention requirements and if you see that as a potential opportunity and how you're thinking about that change in the landscape over the next couple of years?

I think over the next couple of years, we do expect to see some more opportunity in the CRE space just because of the big number of maturities that are coming up and partnering on getting specific loans refinanced within the CMBS space. I don't really have any additional comment on the Dodd-Frank component at this point.

(Operator Instructions) David Walrod, Ladenburg Thalmann.

Good morning. Just wanted to get an update on your thoughts on share buyback given where the stock is trading.

Sure. Stock buyback is something that we always consider, and as you know, we bought back a fair amount of our stock at similar levels I guess towards the end of the 2013, beginning in 2014. We see the -- I mean the biggest benefit of that is accreting book value, but we do -- I mean we continue to be able to accrete our book value pretty handsomely as I said over the last three and a half years and we're also balancing that against retaining financial flexibility and putting capital work and opportunities that we see to really improve the standing of our company over the long term like funding our captive insurance company in order to get some attractive enhancing and to make new investments in CRE and so forth. So, but it is something we always consider.

Mike Widner, KBW.

They have been answered. Thanks a lot.

Brock Vandervliet, Nomura.

Thanks for taking my question. Regarding the real estate, the JV that you mentioned. The earnings for the last two quarters were just been little over a million. Obviously, it was much more visible this quarter. Can you at all kind of frame out what we should be looking for it? It sounds like that's going to drop back, but any comments on magnitude would be helpful?

Well, a few years back, we started a fund that was associated with the PPIP program. And one side of it was the actual PPIP, where we got securities and used the government financing, and the other side was a distressed commercial loan component. And our total commitment to that was about $100 million, both of which got invested in and it was probably close to half each. So in addition to that, we bought a distressed portfolio together with the same group, which was probably an additional like $15 million of our capital. So, that's not a huge percentage of our assets, but what's happened recently is our real estate team has done a fantastic job repositioning that portfolio, re-leasing in certain cases, realizing sales in certain cases and we do think that that probably will continue to be good news. But in the fourth quarter, the valuations that came back were significantly higher than in previous periods. So, as we make realizations in that portfolio, some of that appreciation that we expect to get those realizations is now come through an income unrealized. So, I can't tell you the future. I don't know what will happen over the next two years, but it's been a good investment for us and I would caution not to extrapolate the type of income we got in the first quarter.

Okay. Yes, absolutely. Separately on expenses, by the way I didn't catch the size of your securitization, but the expenses seem particularly well controlled even including the $2.2 million in securitization expenses. So if you could talk about those items that would be great.

Yes, one thing that we focused on this quarter is give people a better understanding of our expenses and breaking down basically what we consider our operating expenses relative to the expenses of the consolidated trust themselves. In other words, we're retaining the subordinate tranches of these structures, we don't -- IVR doesn't have a liability, any economic sense past our investment in those subordinate tranches, but because of the consolidation on our balance sheet we have the whole loan book as an asset. And the asset-backs that the securitization trust issued has a liability. So A, I wanted to make clear that that shows up in our leverage numbers and makes our leverage look higher than it is if you think about what we actually owe. And B, the expenses of those trust are consolidated on our balance sheet. So those are in our expenses. So if you look at what our true expense ratio is, it is more like about 1.8%, which the demand's going to change 1.5%. So, I think we run a pretty tight shift here. We've gotten our expenses down overall, actually when you look at our operating expenses.

Okay. And how large was the securitization?

I think $300 million.

(Operator Instructions) And let's just wait for a few more moments more additional questions. Go ahead, sir.

We will end the call here. Thank you and thanks everybody for listening. We look forward to next quarter.

And that concludes today's conference. Thank you all for participating. You may now disconnect.