Invesco Mortgage Capital Inc (IVR) 2017 Q4 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to Invesco Mortgage Capital Incorporated's Fourth Quarter 2017 Investor Conference Call. (Operator Instructions) As a reminder, this call is being recorded.

Now I would like to turn the call over to Tony Semak in Investor Relations. Mr. Semak, you may begin.

Thank you, Mark, and good morning, everyone. Again we want to welcome you to the Invesco Mortgage Capital Fourth Quarter 2017 Earnings Call. I'm Tony Semak with Investor Relations, and our management team and I are delighted you've joined us. We really look forward to sharing with you our prepared remarks during the next several minutes, before we conclude with the traditional question-and-answer session.

Joining me today are John Anzalone, Chief Executive Officer; Jason Marshall, our Chief Investment Officer; Lee Phegley, our Chief Financial Officer; Kevin Collins, our President; and Dave Lyle, our Chief Operating Officer.

Before we begin, I'll provide the customary forward-looking statements disclosure and then we'll proceed to management's remarks. 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. 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; 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, forecast and future or conditional verbs such as will, may, could, should, would, as well as any other statements 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 the information in any public disclosure if any forward-looking statement later turns out to be inaccurate. An archive of this presentation will be available on our website, and the audio replay can be accessed through March 7 by dialing (800) 925-4790, or for international callers, 1 (203) 369-3533. Again, we really welcome you and appreciate you participating on our call today, and thank you so much for joining us.

We'll now hear from our Chief Executive Officer, John Anzalone. John?

Good morning, and thank you for joining Invesco Mortgage Capital's fourth quarter earnings call. With me today are Jason Marshall, our CIO; Lee Phegley, our CFO; Kevin Collins, our President; and Dave Lyle, our COO. Jason will follow me and go through the portfolio section, and Lee, Kevin and Dave will join me for Q&A.

I'll begin on Slide 3, where we show an overview of our fourth quarter results. As you can see, we had a strong end to 2017 with core earnings coming in at $0.47 per share, up $0.03 or 6% from the prior quarter, and book value up $0.01 to $18.35 per share. This generated an economic return of 2.3% for the quarter, which brought the economic return for the year to a very strong 14.3%.

We're also very pleased with the full year total returns for our common shareholders of 34.5% in 2017. These full year economic and total return results ranked among the very highest amongst our peer group and reflected some milestone achievements, including the Series C Preferred offering, the 2 consecutive quarterly increases in our common stock dividend, the inclusion of Invesco Mortgage Capital in the S&P SmallCap 600 Index, and 4 consecutive quarters of beating consensus core EPS expectations while reducing book value volatility. For the fourth quarter, the increase in core earnings was attributable primarily to the full quarter impact of the Series C Preferred offering and, to a lesser extent, to a slowdown in prepayment speeds.

Slide 4 breaks down the components of the change in book value during the quarter. While Agency mortgages were a negative contributor to book value performance, the benefit of our hedges exactly offset this drag, while the net impact of our credit risk exposure only mildly reduced book value. I'd like to especially point out the graph at the bottom right, which shows our annualized book value volatility in relation to our peer group. You'll notice that we continue to compare favorably with our peers by this measure. Of course, the recent bouts of increased volatility across our financial markets will likely cause book value volatility to increase across the space, but as I'll talk about in a little bit, perhaps this is not such a bad thing.

We include Slide 5 to highlight how we've continued to compare favorably to our peers across a few key metrics we believe are amongst the best measures of management effectiveness. As highlighted on the slide, Invesco Mortgage Capital is consistently outperforming its peer group average and ranking among the best in earning its dividend. Whether it's economic returns, book value performance or dividend growth, IVR has delivered for shareholders.

I'll wrap up by giving some high-level comments about the current environment and the outlook for IVR. While the fourth quarter was characterized by interest rates grinding higher and risk assets continuing their positive trajectory, the first 6 weeks of 2018 has seen a return of volatility in both the rates and risk markets. Whereas our book value was relatively unchanged during the fourth quarter, we have seen a combination of moves that has taken our book value roughly 5% lower quarter-to-date. This has been caused almost equally by the sharp move higher in rates and the widening in spreads in the Agency sector. Typically, we keep a long position in duration to help offset any adverse moves in credit assets as a macro hedge overlay since the 2 normally move in opposite directions. However, there are occasions when all assets become correlated, and this is one of those times.

Active management is crucial during times like these, and we have been actively reducing our interest rate exposure over the last several months. While we view this decline in book value as temporary, particularly given that the widening in credit spread did not correspond with deteriorating underlying fundamentals, we also believe that these moves will lead to much greater opportunities going forward. Hence, the silver lining in the return of book value volatility that I alluded to earlier. The steeper yield curve, combined with wider credit spreads, is moving the ROEs on more of our target assets closer to accretive levels, so we welcome these new opportunities as they develop and look forward to highlighting how we capitalized on them on future calls.

Finally, I want to make a couple of comments about core earnings and the sustainability of the dividend, as that remains a high priority. Our core earnings have been trending higher the past few quarters as the accretive preferred equity offering, slower prepayment speeds and good reinvestment opportunities have all been tailwinds. We anticipate that further improvements may moderate as we progress further into 2018 as rates markets are reflecting an expectation for higher funding costs as the Fed continues to remove accommodation, which may exert pressure on net interest margins. However, the dividend was recently increased with the expectation that it could be sustained in the near term. And again, we believe higher interest rates will present opportunities in addition to challenges. So it's likely that we will -- would also see ROEs on new investments rise in such an environment, which could mitigate interest-rate risk to some degree. Book value volatility has increased recently for the first time in more than 4 years, but importantly, we remain deeply convicted in the strength of our credit assets and believe supportive underlying fundamentals remain paramount in the performance we ultimately deliver to our shareholders.

With that, Jason will now discuss the portfolio.

Thank you, John. I'll now take some time to discuss portfolio activity for the quarter and elaborate on some of the trends that John mentioned for both the fourth quarter and what we have seen since.

During the quarter, accretive investment opportunities remained fairly limited as spreads moved tighter. Our activity for the quarter was limited to replacing portfolio paydowns, which included some commercial loan paydowns. We did this by purchasing $518 million of 30-year Agency MBS and $162 million of subordinate CMBS. These investments were all purchased at ROE levels of between 12% and 15%. Page 7 contains our current equity and asset allocations. The most notable change here is the 4% increase in Agency MBS as that remains our most actionable accretive investment opportunity.

Turning to book value. Book value was little changed during the quarter as spreads in all of the sectors we invest in moved tighter while the yield curve there flattened. While we continue to be positioned for a flatter curve, our long-duration position did negatively impact book value during the quarter. As John mentioned, we have seen a notable pickup in rate and spread volatility thus far in the first quarter as rates have sold off and the curve has steepened. Additionally, nominal Agency MBS spreads have widened approximately 10 to 12 basis points when looking at the 3.5% coupon. Equity markets have corrected but have since regained much of those losses. Despite the correction in equities, structured credit spreads, most notably CRT, CMBS and Non-Agency spreads, held in relatively well during the selloff and have been now -- are in most cases, tighter this year with the recovery in risk assets.

Much of the selloff in rates and increased volatility has been related to fear of increased inflation and consequently, a more aggressive tightening by the Federal Reserve. The fear has primarily been driven by expectations of an increase in wage-push inflation. While we do see some short-term potential for inflation to increase, it's important to keep in mind that inflation does remain below the Fed's communicated target of 2% when looking at the PCE deflator, their preferred measure. Outside of wages, we don't see much catalyst for a sustained increase in inflation above the Fed's target range, and thus feel the market's myopic focus on inflation recently may be misplaced as companies, we believe, still have limited pricing power and are likely to absorb some increase in wages in their margins.

That said, we have reduced our overall equity duration since the end of the year and continue to be cognizant of the market's focus on what will likely be higher volatility compared to last year. While this is likely to create some challenges and some opportunities, we're confident in our ability to navigate this environment. This concludes my prepared remarks for today. Operator, could you please open the Q&A session? Thank you.

(Operator Instructions) First question is from Douglas Harter of Crédit Suisse.

When you were talking about spread widening, can you just talk about kind of what you think is the more relevant measure, the nominal spread or the OAS? And kind of how those 2 have moved so far in the first quarter?

Yes, we see nominal spreads roughly 10 basis points wider. They did tighten during the fourth quarter and have been at pretty historically tight levels. OAS, on the other hand, has widened probably only 6 or 7 basis points. We tend to focus on nominal because most of the institutions, like REITs, commercial banks, don't really hedge -- explicitly hedge volatility. So we think that nominal is the more relevant measure to look at and is more germane to what ROE you can expect and things of that nature, given that we don't actively increase the vol component of our portfolio.

Makes sense. And can you just talk about kind of your expectation for spreads kind of as we go through 2018 with the Fed reducing its balance sheet?

Sure. Yes, a lot of the widening that we've seen recently has been related to duration extension in the selloff. We do think that ultimately, as the Fed taper program progresses, I think we're still kind of at $8 billion. But by the fourth quarter, assuming that all goes as planned with higher rate levels, they really won't be reinvesting anything because the 20% cap will probably be above what they're receiving in monthly prepays. We estimate, kind of optimistically, that it could result in 10 to 15 basis points of widening. Yes, we could certainly see that moving a little bit wider, but I'd say kind of our worst case is maybe 20 basis points of overall widening over the levels where we started the year.

Some people have more aggressive estimates [out there], up to 30. But I think probably 10 to 15 will ultimately end up being the right number. We're not really -- as my comments on inflation may have indicated, we're not really looking for a big spike higher in yields from -- certainly from these levels. But even at these levels, higher mortgage rates will reduce supply some. And we think commercial bank demand will still remain relatively strong. So that's kind of what's behind our 10 to 15 basis point nominal widening estimate.

I guess with that as a backdrop, how are you thinking about the ability to use this widening we've seen to date as an opportunity to add further to Agency versus kind of the rate risk component?

Yes, I think at this point, we'll still look to cover our monthly prepays, a portion of that in Agency and probably CMBS, unless we get some other accretive opportunities. If we were to have new capital come in -- we don't have any current intent to take up leverage or anything to add to any sector, but if we had some incremental capital come in, I think we'd be comfortable adding agencies. With some of the widening we've seen and the curve steepening, we've seen hedged ROEs move out, maybe closer to 14%-type levels. So we still see it as attractive, but right now, just given kind of the increase in volatility, we would hedge out all the rate exposure. As I mentioned, we have taken down our duration risk some since quarter-end, and we're not likely to add to it anytime soon.

Next question is from Eric Hagen of Keefe, Bruyette, & Woods.

You just sort of talked about it, but can you just elaborate maybe a little bit on how you're thinking about leverage in the current environment?

Yes, I think we're pretty comfortable kind of running at around that 6 level that we've generally been at for the past several quarters. There is some -- I mean, we've see some increase in vol. I think that could continue as people now have varying expectations of what the Fed might do. And you could argue that risk assets are relatively tight, so that's likely to lead to an increase in volatility and potential opportunity, as John said. But I don't think we're to a point where we'd take up leverage right now. Maybe if something looked very compelling to us, if something were to widen and appear compelling, maybe we'd take up leverage a little bit to take advantage of that. But as of right now, I think we'll kind of be right around that 6 area, give or take, [call it, 0.1, 0.2 years] just based on market value fluctuations.

Yes, that make sense. And then how should we think about prepayment speeds in the Non-Agency segment? I mean how incentivized do you think homeowners are to refi or move locations if they've previously been underwater?

Yes, this is Dave Lyle. Obviously, our seasoned Non-Agency bonds, the prepays are not going to be nearly as sensitive to prevailing mortgage rates as on some of the new issue. The Agency obviously, as well as the CRTs, just given the seasoning on those bonds. So it's not a huge matter of rate incentive as you, I think, alluded to. It comes down in a lot of cases to the equity position. A lot of buyers -- prepays have been somewhat suppressed because buyers have been in an LTV situation where they were not able to refi, in that as we see home prices continue to appreciate more recently at an accelerated rate, that does bring more buyers into a position where they do have more options. So that can benefit prepay speeds a bit on discount bonds.

Maybe you can just give us a little color on book value quarter-to-date. That'd be really helpful.

Yes. I mean, we mentioned that it was down about 5% as of -- actually as of last night, I guess, the latest estimate. But -- and really that has been -- most of that has occurred since the end of January. So it's been the last couple of weeks that we've really seen agencies start to widen. So that's kind of where we are.

Yes. And I think, like, agencies should be pretty directional here. So if we see a continued selloff and break above 3% on [tang], you'll probably see mortgages widen some. But we've actually seen them tighten the past several sessions as 10s have kind of hung out around 2.90%, high 2.80s here. So we'll be somewhat directional over the short term. But if -- I think if you kind of stay around this rate level, we'll probably see some decent buying. We'll probably recover some of that widening that we've seen, so -- year-to-date.

Next question is from Trevor Cranston of JMP Securities.

You guys mentioned in the prepared remarks that you typically run with a long-duration position because you'd expect it to have an inverse relationship with credit spreads. And you also made the comment that you've taken down your rate exposure some since year-end. So a couple of questions on that. One, can you say what your duration gap was around at the end of the year? And then the second part, can you just elaborate on how you've reduced your rate exposure since year-end, if it's been through changes in the asset composition or through additional hedges?

Sure. We ended the year with kind of an empirical equity duration, I'd say around 10 to 12 area. We've reduced that 3 or 4 years through swaps and futures hedges since year-end. So we've trimmed. Yes, I'd call us probably in the 7 to 8 area right now for empirical equity duration. Yes, and part of the reason, aside from the general inverse correlation with spread assets that we've kept that on is -- throughout last year, we were pretty confident that rates were going to be range bound. So by not kind of [delta] hedging duration moves within that range, you're preserving income and book value in a lot of cases. So we try to be patient and -- based on our view, and establish a range to where we'll kind of allow rates to drift so we're not kind of delta hedging away profits and book value. Now certainly, we've broken out of that range here this year, but we think that it's pricing and increase in supply and increase in inflation expectations. But I think we could start to see some signs of stability here, but clearly, there is some more risk to higher rates, so that's why we're kind of tightening up that duration position a little bit more.

Okay. That's helpful. And then the second question, just a point of clarification on the comment that book values declined about 5% since the end of the year. Can you say if that includes accrued earnings for the quarter so far, or if that's just a pure mark-to-market number?

That's just a clean mark-to-market number.

We show no further questions on queue. (Operator Instructions)

No additional questions on queue, speakers.

Okay. Well, again, we want to thank everyone for the -- for participating and joining the call. And we appreciate your interest. And certainly, if there are follow-up questions or points of clarity that you might need, we're happy to help with those along the way. So thanks again. Have a great day, everyone. Take care.

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