Invesco Mortgage Capital Inc (IVR) 2016 Q3 法說會逐字稿

This presentation and comments made in the associated conference call 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, 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 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 caption Risk Factors. Forward-looking statements and management's discussion and analysis of financial condition and results of operations in our 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's Third Quarter 2016 Investor Conference Call. (Operator Instructions) As a reminder, this call is being recorded.

Now, I would like to turn the call over to Mr. Richard King.

Sir, you may begin.

Thank you. Good morning to all and thanks for joining today. We're pleased to announce the third quarter Invesco Mortgage Capital core income of $0.41. Core earnings were above the dividend of $0.40, down a penny relative to the second quarter $0.42 due to a more conservative portfolio mix and somewhat faster prepayment speeds. Prepay speeds were higher due to both lower interest rates earlier in the summer and higher seasonal housing turnover. Book value improved $1 per share or 5.9% in Q3 due to narrowing or improving credit spreads. I mentioned on our second quarter call that we expect the credit spreads to contract in this low volatility, low interest rate environment, and that is what occurred. In Q3, our comprehensive income was $1.40 per share. Our economic return, the change in book value plus dividends paid divided by the beginning book value was 8.2% for the quarter. Economic return has been 12.5% year-to-date through September. Our portfolio is positioned relatively conservatively with 44% of our equity invested in primarily shorter maturity Agency MBS. In the third quarter, we used cash flow from principal and interest payments and increased capital due to appreciation in our portfolio to extend our investment in 15-year Agency MBS. We also reduced leverage in the portfolio. Our Agency MBS debt to equity and leverage was reduced to 7.9 times from 8.6 times last quarter and 9.7 times at March 31. Our total debt to equity has been reduced to 6 times from 6.3 times at year end 2015, and that's despite missing our equity allocation from 33% to 44% Agency MBS. Agency MBS, obviously, have higher leverage relative to our credit positions.

Importantly, due to the repositioning of our Agency MBS portfolio, we have much less maturity extension risk, less book value risk and better investment flexibility if we do see either higher rates, a risk episode in the markets or some exciting investment opportunities with new risk retention rules about to take hold in the fourth quarter. We see higher potential for tighter financial conditions in the next couple of quarters due to the presidential and congressional elections, a probable December rate hike, increased regulation and not just risk retention, but also capital required for banks trading books. Further, there is the aftermath of money market reform, Brexit negotiations and just the potential impact on US and world economies from stronger dollar and delevering. We believe we are well positioned to capitalize on opportunities that may present as a result. I'm pleased that we've been able to significantly reduce risk and still earn our dividend. John will go into more detail about our high quality portfolio. But first, let's look at slide 4 in the presentation and more specifically at the components of the change in book value.

As I mentioned, credit spread tightening drove our book value per share by a dollar higher. Here, we disaggregate that net change into gross components. Rising rates in Q3 improved our swap hedges valuation. It's labeled here as derivatives contributing $0.54 to book value per share. Our efforts to shorten the Agency MBS portfolio and Agency MBS spread improvement limited the downside price movement from this component to $0.20. The CMBS and residential credit portfolio appreciated smartly despite higher rates and together contributed $0.65 to book value per share. Most of that outperformance was in the residential component as the GSE credit risk transfer market outperformed all others securitized sectors again this quarter. We paid $0.40 income and dividends of the $0.41 of core earnings. We're very happy with the way things are going in the portfolio with an attractive dividend, strong and improving asset quality, lower interest rate risk and declining book value volatility. We have room to increase risk when we see opportunity.

Since our last earnings call, I announced I'll be retiring March 1, 2017. And I'd like to take this opportunity to thank all of our shareholders for your trust in us. The team here is quite talented and accomplished and it has great depth, and we've had very low turnover. Most importantly, we're focused on the right thing, which is the shareholders. I'm fortunate to have the opportunity to lead this team and this company. Invesco has the resources and platform to excel in both residential and commercial. I'm confident IVR will be an important player in both the CMBS and non-Agency RMBS markets for years to come. And we'll continue to find the best risk-adjusted returns across the mortgage market.

In the long run, the major driving force behind the returns to IVR shareholders is the high level of dividends relative to pretty much any other equity group.

Total returns on IVR's stock have been among the best in the industry over the last one, three and five years. We produced 15.4% annualized return over the last 5 years and 12.4% over the last 3 years, while the Bloomberg mortgage rate index, I believe, is around 9% over those periods. We expect to drive shareholder returns with strong and stable income and to see additional return from lift in the stock price as we do expect the discount will continue to narrow.

Now, I'm happy to introduce John Anzalone, our CIO and next CEO to cover our investment strategy and current portfolio positioning.

Thanks Rich, and thanks again to everyone joining us on the call this morning. I'll start on slide 6 with the portfolio review. Over the past few quarters, we have focused on maintaining a high quality credit book while improving our liquidity position. This will be important as the market faces a number of potential sources of volatility over the balance of the year. Elections, Fed meetings and Brexit negotiations to name just a few. Having redeployed recent cash flows into 15-year Agency paper allows us to keep some powder dry to redeploy into credit assets when spreads widen. In the meantime, 15-year Agencies provide great liquidity, have better convexity characteristics and have a shorter duration profile. Often, this should be valuable over the coming months. Currently, we have 44% of our equity allocated to Agencies with 56% allocated to credit. As I will discuss shortly, while we're still favorable on credit fundamentals, we are simply waiting for an opportunity to purchase credit at wider spreads in the future.

Let's move to slide 7 and Agency mortgages. With the recent purchases of call protected 15-year collateral, our Agency portfolio is well balanced between high coupons specified for 30s, 15s in seasoned hybrid ARMs. This gives us an Agency bucket that is relatively defensive in nature with less exposure to interest rate risk and convexity risk. Speeds have ticked up recently, but we expect to see those moderate due to higher rates as well as seasonal factors.

Moving to slide 8 and residential credit, our residential credit book continues to contain a good mixture of legacy positions, more recent securitizations as well as CRT bonds. Overall, the housing market remains strong, supported by favorable trends in employment and demographics along with limited supply and low mortgage rates. Our credit performance is benefiting from strong house price appreciation and borrower performance. Over the quarter, spreads tightened considerably as we continued to see demand for credit assets in general and housing assets in particular. Underscoring the favorable fundamental environment, we saw positive ratings actions in our CRT book as Fitch-assigned ratings of $353 million of our previously unrated bonds and upgraded another $7 million to investment grade. While this obviously validates our favorable opinion of these bonds, it also has tangible value as financing terms improve along with ratings upgrades.

Slide 9 provides a snapshot of the credit quality of our residential credit portfolio. The big picture takeaway is that this is a very high quality book. The chart on the left shows the average dollar prices on our portfolio. These high dollar priced bonds tend to have fewer issues with collateral performance, less price volatility and allows us to get financing at favorable terms. The chart on the right shows a breakup of the portfolio by vintage and sector. As you can see, the legacy paper is high quality Prime in Alt-A paper, while our CRT positions are largely from 2013-2014. This is important because these vintages have lower price volatility, while still benefiting from the positive trends we've experienced in house prices.

On Slide 10, we take a look at our commercial book. The story here parallels the story in residential credit as the fundamentals are positive as well, and we own a high quality portfolio. In CMBS our positioning has been good with concentrations in A, BBB from 2011-2012, that have benefited from the run-up in commercial property prices and the strong underwriting from those vintages in AA, AAAs from 2013-2014, which we're financing at favorable terms due to the home loan bank.

Slide 11 gives an update on our commercial loan book. It stands at a little over $300 million and has experienced no delinquencies. We have been relatively quiet here recently as we await opportunities that the new Dodd-Frank imposed risk retention brings.

Slide 12 shows a snapshot of the credit quality of our commercial credit portfolio. The loan-to-value ratios remain remarkably low with the average LTV on our commercial loans of 67% and the average LTV in our CMBS at only 34%. A full 94% of the loans underlying our CMBS were originated pre 2014 and the properties behind these loans had experienced strong property price appreciation over the past several years. Our newer paper is, predominantly AA, AAA, which has higher subordination levels to begin with, and as we saw in the previous slide, our CRT positions are all performing well.

Finally, Slide 13 in financing, the financing market remains very robust, while we have seen a small increase in financing costs as LIBOR increased due to money market reform. This was largely offset by the receipt side of our swaps as well as by the increased payments on our LIBOR-based floating-rate assets. Further, our home loan bank financing is indexed off of the home loan bank cost of funds index and that did not increase along with LIBOR.

That's all we have for prepared remarks. Operator, could you open the floor to questions.

(Operator Instruction) Douglas Harter, Credit Suisse.

First of all, Rich, congratulations on the retirement. I guess, John, when you're looking at the CRT assets given how much those spreads have tightened, can you talk about the relative attractiveness of those today and whether you would look to sort of scale back that position sort of ahead of the volatility events that you've highlighted?

Yes. We like what we own now. I think the key is that what we own is basically pretty well seasoned from 2013-2014. So we like those positions still. We've been cautious about adding more at current levels certainly in new production-type paper. So, I think we're kind of waiting around for spreads to widen a little bit before we add more. But fundamentally, I mean, we still really like the paper. It's just a matter of price level.

Okay. And I guess what have CRT spreads done so far or what did they do in October?

I think in October, things have been relatively flat to a little bit wider. Generally speaking, since quarter-end, we've seen credit spreads across most of the structured security space flat to slightly wider. (Multiple speakers).

18 basis points or so in first [loss], not the [B tranches] but in the unrated tranches like we --.

And I guess with Fitch rating that one tranche over that one group of securities, is that something that is likely to continue and is that something where you could expect further benefits from that or is that kind of a one-off situation where Fitch rated those securities?

It could continue, we can't really predict what Fitch is going to do, but certainly from when those securities were issued, there has been tremendous amount of home price appreciation and so the subordination required is much less. So it could continue.

Joel Houck, Wells Fargo.

Rich, congratulations on the retirement as well. So, just to kind of continue along the theme on the credit side. When you look at your overall opportunities between commercial CRT and kind of legacy paper where -- obviously they've all been performing well this year. But on the margin, if you had to handicap where to put new capital, how would you kind of rank order the investment opportunities set on the credit book?

Right now, the legacy stuff is probably the most attractive given that it's at this point pretty low volatility, pretty short and given that you know we kind of think credit spreads are relatively narrow at the least volatility. And also, in CMBS, we're kind of at the cusp of risk retention happening in another six weeks or seven weeks, I guess. So, it's a little bit hard to tell what opportunity is going to be there because we haven't seen exactly how that's going to play out yet. So that one's a little bit harder to handicap. But we do expect to see pretty good opportunities in CMBS once those rules take place and once we kind of see what the [leveling] looks like.

Bose George, KBW.

It's Eric on for Bose. And Rich, congratulations on your retirement. I want to talk about leverage. It looked like it did tick down. And I'm curious, if that's just due to the appreciation in book value and where you see that trending and where you're kind of comfortable with the portfolio, especially as you rotated a little bit more into Agency?

We took leverage down on purpose, for sure, and it's been over several quarters and really for the reasons we've talked about, just to reduce book value volatility and wait to put capital market better levels. In front of Fed meeting, it makes sense to reduce kind of our duration risk and convexity risk. So we liked the 15-year space. So that's really it. And I think, you would have seen our leverage drop a lot more on a holistic basis if we'd kept the same mix but because the mix moved from non-Agency and CMBS, which are at 3 times to the Agency, which we've had between 8 [on] up to 10 times at times. We've really reduced leverage quite a bit given that it came down despite increasing that Agency component.

And to your point on volatility in the curve and the Fed raising rates, would you think about putting some hedges onto the longer end of the curve? How do you think about restructuring the hedge portfolio potentially heading into next year?

Yes. We're probably more inclined to hedge like the belly of the curve rather than the long end. Most of our duration is more in the belly rather than the long end.

Okay. And I wanted to just quickly ask on the Dodd-Frank risk retention stuff. Maybe you can elaborate just a little bit. In an ideal world once that takes effect, what would the environment have to look like again sort of in an ideal state to get you a little more excited about the market.

As far as the risk retention rules?

Yes. I think you meant, if I heard your statements correctly, you are taking a sort of defensive posture until those rules go into effect. So what would the environment have to kind of shape up to look like or what would have to happen in order for you to get a little more excited about that?

Well, yes, that I mean, maybe I misstated that a bit. I think we're looking at that as an opportunity that's likely to present opportunities for private capital to be able to put money to work in the space where -- that didn't exist prior. We're not nervous about how those rules come out. That's the credit spreads in front of the election and Fed meeting and Brexit is really more what could increase volatility, and actually, we've just seeing that in the last few days and the BEX index pretty much, it's the highest since the Brexit was announced. So we are seeing a little bit of that. Hopefully, there won't be any, and that's fine. But I think we just think it's prudent and that we hold a bit of -- more unencumbered assets and so forth in front of year end and look for opportunity in the beginning of the year probably.

Right. I would add on the CMBS, and I think what we're looking for is with risk retention rules, part of the idea there is that there would be better alignment of interest between issuers -- with issuers and we think that, that should present better opportunities to invest at lower levels down the capital stack with better underwritten properties. So I mean, that's like, I think, the main takeaway. Whether we get an opportunity to partner with the issuers in actually taking down those retention pieces where we need to hold them for five years and (inaudible), that remains to be seen on how that's going to play out. But certainly, we think there's going to be opportunities regardless of how it shakes out to invest in better underwritten properties and potentially down the capital stack, which should provide better spread levels.

(Operator Instructions) Trevor Cranston, JMP Securities.

Congratulations to Rich. Given the kind of conservative stance you guys are taking ahead of some potential volatility, can you talk about maybe how you're thinking about potentially buying back shares where they're trading today versus continuing to build liquidity for potential investment opportunities over the next few months? Thanks.

I mean, we look at constantly where our stock's trading and the relative opportunities between buying back shares and investing. I think the current focus was to increase liquidity and decrease leverage, which are both kind of uses of liquidity and uses of our capital, if you will. So, buying back shares is not on the front of our mind right now because that -- use that space in the portfolio and that opportunities set that it just opened up and take it away. So that's short answer of that, but basically what we're looking at is let's get through the next couple of months and then assess the best opportunities, whether that be share buybacks or putting money to work in risk retention or wider spreads on credit, et cetera.

At this time, we have no further questions.

Well, thank you everybody, appreciate your interest, and we will talk to you next quarter.

That concludes today's conference. Thank you for participating. You may now disconnect.