Invesco Mortgage Capital Inc (IVR) 2017 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Invesco Mortgage Capital Incorporated's Third Quarter 2017 Investor Conference Call. (Operator Instructions) As a reminder, this call is being recorded. 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 U.S. 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 including 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; 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 feature 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'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 this information in any public disclosure if any forward-looking statements later turns out to be inaccurate. Now, I'd like to turn the call over to your host, Mr. John Anzalone. You may begin.

Good morning, and thanks for joining Invesco Mortgage Capital's Third Quarter 2017 Earnings Call. Management team and I appreciate your participation today and we look forward to sharing our prepared remarks and receiving your questions during the Q&A session that will follow. I'll begin by providing a few highlights for the recent quarter and our outlook, if I transition the call to Jason Marshall, our Chief Investment Officer, who discuss our investment portfolio more detail. I'm joined on today's call by Lee Phegley, our CFO; Kevin Collins, our President; and Dave Lyle, our CEO, who will be available to answer questions during the Q&A session. I'm pleased to announce that IVR delivered another solid quarter, with core earnings per share of $0.44, an increase of $0.03 per share or 7.3% over the prior quarter while book value increased modestly to $18.34. This produced an economic return of 2.6% for the quarter and brought our year-to-date economic return up to 11.8%. This strong performance was highlighted by the mid-quarter issuance of $287.5 million of our Series C Preferred Equity. We were successful in investing all of the preferred equity issuance proceeds in assets with accretive ROEs before the end of the third quarter, which contributed to the incremental improvement in earnings, though the full quarter benefits are yet to be realized until the fourth quarter and beyond. Book value was up modestly during the quarter as we once again realized the value of our diversified portfolio. While credit risk transfer bond spreads widened in response to the potential impacts on collateral from Hurricanes Harvey and Irma, this was offset by contributions from a legacy residential mortgages, commercial mortgages, as well as agencies. I'll draw your attention to the graph on the bottom of Slide 4, which shows that our book value volatility continues to fall, which reveals an important part of our value proposition.

Importantly, our book value volatility also continues to fall at a faster rate than our peer group average over the past nearly 5 years, on a rolling 3-year basis. On Slide 5 I'd like to point out some key performance metrics in relation to our peers. Over this or any calendar year or annualized timeframe during the past 3 and 5 years, we have delivered economic returns that have outperformed our peer-group average. Well just to illustrate how the volatility of our book value has fallen over the past nearly 5 years, the box in the middle of Slide 5 shows our book value performance compares. In each period, we've outperformed and I point out the 5-year number in particular. While our book value has been relatively flat over the past 5 years, down less than 1%, our peers on average have lost nearly 19% of their book value. Finally, we compare dividend performance, not only did we increase the common stock dividend during the quarter, we've been successful in earning that dividend. Our core earnings per share has been in line or above the credit dividend level during 10 of the past 12 quarters. Before I turn the call over to Jason, I'll take a few minutes to discuss the factors that contributed to our increasing core earnings as well as our outlook for the next few quarters. As I pointed out earlier, the accretive benefit from the issuance of preferred equity was a tailwind during the quarter and will continue to benefit us going forward. We are still seeing very good investment opportunities in 30-year agencies and in select subordinated CMBS, with hedged ROEs in the low teens for each. We believe prepayments fees will continue to slow as the housing market feels the impact of seasonal factors, and this will be supportive of returns on both agencies as well as residential credit. There are 2 other factors which are interrelated that will combine to help support the positive trajectory of our earnings stream. Our commercial loan book, which now stands at $300 million, is beginning to pay down. While there are many aspects of that asset class that we like, return opportunities have diminished as new entrants have flooded the market. Whereas we are realizing returns in the LIBOR plus 8% to 9% range during 2013 to early 2016, returns on new loans have contracted notably. So as these loans mature, we are recycling that capital back into much higher yielding assets. Related to that, we issued a $400 million exchangeable note in 2013 that is coming due in March of 2018. One of the reasons we're issuing that note was to provide stable financing to the commercial loan effort. Over the course of 2017, we have paid down almost $250 million of the note and will pay off the remaining balance prior to maturity date in March. This also serves to positively support our earnings per share outlook as we are replacing relatively expensive fixed-rate financing with lower cost Repo. As far as our broader outlook, we remain positive on the fundamentals that underpin our residential and commercial credit books. Our credit portfolio is well seasoned, and as such, has benefit from the impressive property price increases across both residential and commercial collateral, because spreads have continued to tighten, we have been extremely selective in adding to our existing credit book. Agency mortgages have also been well supported despite the fact that the Fed has begun to taper its portfolio. The slow pace of this reduction has been more than offset by increased demand from commercial banks. While we believe that agencies will come under some pressure as the Fed taper picks up steam later in 2018 and '19. In the near term, we believe agency spreads will remain well supported. To wrap up, we believe IVR's diversified portfolio is well-positioned for the current environment and that the positive trajectory of our core earnings stream should continue to be well supported while we -- while creating the potential for further common stock dividend improvement. With that, let me call -- turn the call over to Jason who will review the portfolio.

Thanks, John, and likewise, thanks to everyone for joining our call today. I'll provide a short summary of our portfolio highlights before we conclude our prepared remarks and open the Q&A session. While the core earnings increased and book value increased during the quarter with positive outcomes, we view the highlighted third quarter as a speedy deployment of our $287.5 million preferred issue proceeds that occurred in August. On a net basis, we added approximately $2 billion of 30-year agency 3% and 3.5% and $331 million in primarily investment grade CMBS, both with hedged ROEs in the 13% to 14% area. Accretive investment opportunities in the RMBS sector remain limited during the quarter resulting in a decrease in portfolio exposure of $155 million for the quarter, primarily due to pay downs. While we continue to maintain a long-duration position, we did add $1.2 billion of new swatch that hedged some of the purchase activity related to the preferred proceeds and we maintain a overall profile biased towards a slight flattening in the yield curve. Lastly, on the financing side, as John indicated, we continue to repurchase the outstanding convertible note that matures in March of 2018. Retiring another $16.9 million during the quarter, lead by also approximately $158 million lapse. I'll now briefly discuss the performance -- sector performance during the quarter, before moving on to the Q&A. During the quarter, agency MBS, CMBS and legacy of RMBS all tightened, while CRT experienced some widening due to the impact of the storms in Florida and Texas, which our credit team does not expect those to have material impact on credit. Our generally more seasoned CRT portfolio also help mitigate some of this impact. Tightening in agency MBS was driven by strong commercial bank demand, as loan growth remains somewhat back cluster, while CMBS benefited from an overall favorable return in the risk market and continues -- continued positive fundamentals in commercial real estate. While spreads remain historically tight in many of the sectors in which we operate, we continue to have a positive fundamental outlook in residential and commercial credit and agency MBS. We are, obviously, closely following the Fed balance sheet reduction program and spreads have remained very resilient at the start of the program, we do expect to probably see some widening and some increase in spread volatility, but don't expect a dramatic impact over the intermediate term. Given the activity during the quarter, coupled with our market and economic outlook, we expect a trajectory of core earnings of dividends to trend higher during the next several quarters. For the fourth quarter specifically, we will realize the full impact of the investment of the preferred proceeds and as John noted, agency RMBS will receive some seasonal benefit of slower turnover in the housing market. Thank you again very much for participating in our call today. That concludes our prepared remarks. Operator, could you please open the Q&A session. Thank you.

(Operator Instructions) Our first question is from Eric Hagen of KBW.

As the exchangeable notes roll off in March, perhaps, you're not in commercial loans anymore but how you do you think about putting on other forms of term financing? Maybe you guys -- have you explored another preferred capital raise as well?

Yes. Yes, I would say in terms of preferred -- and we just did a preferred, and I think, for where we are in our -- where our capital structure is now, we're pretty comfortable with the amount of preferred we have on right now. And exploring other longer-term financing options like converge and things like that, and we're always looking at that. For now, because we've been buying back the existing note over time and, kind of, in pieces as we can buy it back, and it's been a slow process and rolling it into Repo has made the most sense, but we're all always looking to improve our capital structure.

Great. Yes, that's helpful. And then if you can just maybe give a little more detail about the rotation of CMBS during the quarter? Where in the stack are you buying these bonds and how much additional tightening do you really see left in the credit market, especially -- well if you can address both CMBS and RMBS, that would be great.

Okay. Yes, I'll -- Kevin Collins, who runs our commercial effort is -- and is our President, is online, I'll let him handle the CMBS portion of that.

Sure. To address that, our focus has predominantly been in the BBB and B-piece portion of the capital stack. We've been -- positively, we've been able to go in and add loans that were originated several years ago. So since that time, property prices have appreciated, and as a result, we believe we're benefiting from what is essentially a decline in LTV ratios, but at the same time, we are also adding exposures to new originated loans as well, again, in BBB and BB space predominantly.

Great. And then if you could just talk about how much tightening you really see left in the market. I mean, it's pretty extraordinary how tight credit spreads are right now.

Yes, I guess, what I would say on that note, as it pertains to commercial real estate credit is the fact that, at the top of the capital structure, we've seen notable tightening, so there's certainly no disagreeing to that. Where we have seen a little bit more of the lag has been at the bottom of the capital structure. So there, we're still finding good value and are looking for bonds that we want to hold on a longer basis and we think are still generating a really nice ROE. I would say that, on the commercial real estate mezzanine loan side, we're seeing underrating -- underwriting quality, by and large, holding fairly well, and that's been a positive, but one thing I would note is that yield premiums have contracted as the space has just seen a growing number of entrants. That's how we'll keep looking for opportunities on both sides.

Yes, Eric, I'd say, you mentioned RMBS earlier, I think on the RMBS side, as far as the spread outlook, we're not necessarily expecting significant spread tightening from these levels. I think, to your point, most of the tightening is behind us, that's not to say that we couldn't continue to, kind of, grind tighter at a slower pace here for the foreseeable future. But given that much of our book was put on at cheaper levels and it's generating a book ROE, that's quite attractive. We're happy to continue to hold those assets without the expectation of kind of continue price appreciation.

Our next question is from Doug Harter of Crédit Suisse.

Could you talk about how agency spreads have performed so far in the fourth quarter and your expectations there?

Yes, Jason, do you want to take that one?

Yes. We wanted to kind of the announcement of the Fed taper program, the types of the year. I think, we've drifted maybe just marginally wider since then, but spreads have been very resilient and still remain at tight levels, whether you're looking at a 1 or 3-year, 5-year type chart. I think, we've seen very strong bank demand. If you look at some of the big bank earning reports, your loan growth, I think it's still below where they would like it to be. So obviously, they're using MBS market to add some asset exposures. The deposits continue to grow, and we really don't see that dynamic changing. As the Fed gradually does increase the amounts that they don't reinvest as they've laid on the program assuming the trajectory of the programs remains as they've laid out. We do expect spreads to widen some. We've generated at the lower end of the range of some of the estimates that we've seen. Initially, we're taking maybe 10 basis points over the intermediate term as we see MBS spread volatility pick up at the market. Is the market supposed to absorb some of that, that was otherwise being reinvested by the Fed. So we are at -- currently at tight levels and we do expect some widening, probably over the next several months, as this program continues to evolve, but we don't see dramatic widening on the horizon.

And then, can you just talk about your interest rate versus exposure to the end of the third quarter or today, kind of, given the tradition of the agency portfolio during the quarter?

Sure. We've been running at empirical durations of roughly 4 years during the quarter and at the end of the quarter, and I don't expect that we would go any longer from there. Although, we see our empirical durations start to increase from these levels. It's likely that we will take some action in the hedge book. Yes, but we do think that rates, especially longer rates, are likely to remain range-bound, Maybe call it 2% to 2.50%, 2.60% in the 10-year note. So we've a lot of empirical duration to drift within that band instead of dull the hedging with some of our earnings power. But it's something we're always monitoring, and certainly, this -- I would characterize this as, kind of, the longer end of where we would operate.

And just given low volatility, what are your current thoughts around, kind of, optional hedging?

Yes, it's something that we look at. We always periodically look at potentially adding some options but volatility has been low for quite a long time and we're -- seeing a -- I mean, it's always hard to identify the catalyst that results in short-term spike in volatility, but as of right now, I think, we don't have any immediate plans to add some options or optionality to our hedge portfolio.

Our next question is from Trevor Cranston from JMP Securities.

Question on the agency portfolio. I mean, it sounds like you continue to find some attractive operations in the 30-year sector. I was wondering on the remainder of the portfolio, and specifically the Hybrid ARMs, can you tell us how long those ARMs are generally to the reset date? And can you also comment more generally on how you'd expect that part of the portfolio to perform if the yield curve continues to flatten?

Yes. I think -- I don't have the information right in front of me but I think the average months to roll on that book is probably right in 4- to 4.5-year area. Speeds have been relatively contained there. We've concentrated our book mostly in Tier 1 issuers that our little of less responsive to prepayments to some kind of credit and non-bank affiliated originators so our pre-pay experience has been favorable. Certainly, we do continue to get a flattening of the curve. We would expect to see some increase in speeds, especially as those borrowers get closer to their reset. So it's something we're concerned about and something we're keeping an eye on. But don't expect an immediate impact as we generally still have 4-plus years of the fixed period left for those borrowers.

Got it, okay. And on the financing side, I mean, recently, we've heard from some companies who have been able to add like non-mark-to-market financing, specifically for credit assets. Can you guys talk about what you guys are seeing in terms of the financing markets for credit in particular? If you're seeing any improvement in terms of increased liquidity there?

Yes, sorry about that, we -- yes, I think, generally speaking, we've seen financing levels for credit have been pretty steady, and we haven't seen a lot of changes within that. We have not done any sort of term facilities lately, but then we're always looking at those so when they make sense, really for the kind of assets we've owned, Repo has been the best option at least in the current environment in terms of where our financing rates are.

Next, we have Eric Hagen of KBW.

Just, if you could just give us a little color on book value, quarter to date, that would be really helpful for us.

Yes, I think, book value estimates as of last night were very flat to maybe up just a tiny bit since quarter end. So, I guess, Jason's mentioned, agencies have lagged a bit and, I think, CRT has come back from -- has retraced a lot of the widening that we saw at the end of the last quarter and, I think, CMBS and legacy RMBS have been, I would say, relatively flat to may be a little bit tighter. But generally speaking, I think, we're flat to up just a hair.

(Operator Instructions) At this time, we have no questions on queue. (Operator Instructions)

Okay, operator. Since there are no further questions, we will wrap up the call.

Okay, sir, there are no questions.

Okay. Well thanks, everyone, for joining us.

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