Invesco Mortgage Capital Inc (IVR) 2018 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the Invesco Mortgage Capital Incorporated Second Quarter 2018 Investor Conference Call. (Operator Instructions) As a reminder, this call is being recorded.

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

Thanks, Jeyard, and good morning, everyone. Again, we want to welcome you to the Invesco Mortgage Capital Second Quarter 2018 Earnings Call.

I'm Tony Semak with Investor Relations, and our management team and I are delighted you've joined us 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 John Anzalone, our Chief Executive Officer; Kevin Collins, our President; Lee Phegley, our Chief Financial Officer; 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. 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 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, forecasts and future conditional verbs such as will, may, could, should and would as well as any other statement that necessarily depends on future events are intended to identify the 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.

To view the slide presentation today, you can access our website at invescomortgagecapital.com and click on the Q2 2018 earnings presentation link you can find under the Investor Relations tab at the top of our homepage. There you may also select either the presentation or the webcast option for both the presentation slides and the audio.

Again we welcome you and really appreciate your participation today. And we want to thank you for joining us. We will now hear from our Chief Executive Officer, John Anzalone. John?

Thank you, and good morning, and welcome to IVR's second quarter earnings call. Joining me to help with Q&A following my prepared remarks will be Lee Phegley, our CFO; Kevin Collins, our President; and Dave Lyle, our COO.

I'll start on Slide 3 of the presentation with an overview of our second quarter results. Core earnings per share were $0.41, down from $0.45 last quarter. The decrease in core was driven primarily by an increase in our funding costs as well as by a slight decrease in earning assets, following the repayment of our senior note in March. Book value was relatively flat, down about 0.6%, as stable credit spreads and a disciplined hedging strategy helped offset the impact of higher interest rates. The change in book value combined with our dividend brought our economic return for the quarter to 1.9%. While we expect that further policy action by the FOMC will be a headwind, we also see tailwinds in the form of seasonally lower prepayment speeds and an attractive reinvestment environment across several asset classes, which I will highlight later in the presentation.

Further, we are confident that active management in both asset allocation and hedging will lend support to earnings going forward.

On Slide 4, you can see the components of the change in book value. I'd like to highlight the chart on the lower-right hand side of the slide, which shows the volatility of our book value on a trailing 3-year basis. We have consistently been able to reduce our book value volatility over the past 4 years and with our active hedging strategy expect to keep book value volatility contained. So far this quarter, we've seen relatively little book change -- little change in our book value.

Slide 6 highlights our diversified portfolio. Our equity allocation remains well-balanced with 48% in agencies and 52% in credit. This is important because our credit book exhibits favorable duration and convexity characteristics, which help offset the negative convexity of our agency MBS. Credit fundamentals are strong across the board, which I'll be highlighting a bit later. We had about $400 million decline in average earning assets during the quarter, as we paid back our senior note just before the start of the quarter. This caused a slight drag on core earnings, which we've worked through, and we expect to benefit from an incremental increase in earning assets going forward.

Starting with agencies on Slide 7, I'll go through a brief overview of each sector. Our agency portfolio is well diversified with the mix consisting of 63% specified pool 30-year collateral, 20% 15-year paper and 14% hybrid ARMS. The specified pool 30s help mitigate prepayment risk, while the 15s and hybrids are naturally shorter in duration. Prepayment speeds remain well contained, and we expect to see some benefits as speeds slow down as fall and winter seasonal impacts take hold.

We can continue to see accretive investment opportunities in 30-year fixed-rate agency mortgages, with hedged ROEs in the low teens, as modestly wider spreads since the beginning of the year have partially offset higher funding costs and expect to capitalize on opportunities to increase income through allocations towards higher-yielding agency MBS. We've also begun to see some attractive opportunities in Agency CMBS. And while Agency CMBS do not have quite as high an ROE, they have a favorable convexity profile, making an easier hedge precisely.

Moving on to commercial credit on Slide 8. Our CMBS portfolio consists of a combination of well-seasoned single A, AAA (sic - see slide 8, "A+/BBB-")bonds, financed with multiple counterparties and AA, AAA paper that is financed at the Federal Home Loan Bank. Fundamentals remain strong as favorable trends and property prices have provided support for the sector. Tighter credit spreads have made it more difficult to find opportunities within CMBS, but we continue to find pockets of value in the sector.

Slide 9 highlights the credit quality of our commercial portfolio. The chart on the left shows the average LTV in our CMBS and CRE loan portfolios, where they have average LTVs of 36% and 67%, respectively. The chart on the right highlights the seasoned nature of our CMBS book, and I point out that our single A, BBB bonds are largely from 2014 or earlier.

Positively, seasoned subordinated bonds experienced incremental credit spread tightening over the quarter, given increased investor demand. We think these bonds will continue to benefit from contracting spread duration and better property price appreciation, and in some cases, deleveraging from loan paydowns. Our commercial loan portfolio continues to decline with a balance of $157 million at quarter-end and a weighted average maturity of less than one year.

Slide 10 covers our residential credit portfolio. This portfolio is also well diversified with 41% in GSE CRT paper; 38% in legacy bonds and Re-REMICS; and 21% in post-2009 prime paper. We added $123 million of nonagency mortgages during the quarter as available ROEs improved, thanks to modest widening in new issue spreads and improved financing terms. Fundamentals are also strong here, as economic strength and healthy consumers are more than offsetting the impact of higher mortgage rates. And despite some softness in recent sales data, home prices remain well supported by tight supply and strong demand, and default rates remain very low.

Our investments are largely backed by moderately priced homes with minimal exposure to high-end properties in high-tax areas that are beginning to show the negative effects of recent tax reform. As you can see from the chart at the bottom of the slide, durations are very low across the portfolio. Spreads here have also been very well supported, as positive fundamentals and negative net supply have led to modest spread tightening during Q2.

Slide 11 covers the credit quality of our residential portfolio. As you can see from the charts on this slide, fundamentals remain strong. The dollar price of the book is largely above $90 and high price bonds typically exhibit less pricing spread volatility, affording them favorable financing terms. Our legacy positions consist of prime and Alt-A paper that we purchased relatively early in the recovery at high book yields. While our CRT positions are concentrated in earlier vintages, which have experienced more embedded home price appreciation and rating agency upgrades relative to the outstanding CRT universe.

I'll end on Slide 12 with financing and hedging. At quarter-end, we had $13.7 billion of repo outstanding. To reduce risks associated with changes in repo funding costs, we held $8.9 billion of interest rate swaps. Additionally, $1.9 billion of our assets pay a variable rate, further offsetting funding cost exposure. In addition to our swaps and floating rate assets, our $285 million treasury futures position lends protection against higher rates.

Also, our sizable portfolio of subordinate credit investments has historically traded with limited interest rate sensitivity, further reducing our duration risk. Since quarter-end, we've added another $400 million of swaps and $325 million of treasury futures to further protect our cost of funds and book value. As we move through Q3, we will continue to actively manage our portfolio to optimize our earnings capacity while limiting the impact of higher interest rates.

That ends my prepared remarks. Now we'll open the call up for Q&A.

(Operator Instructions) Our first question comes from the line of Doug Harter from Crédit Suisse.

This is actually Josh Bolton on for Doug. Just one, are you guys able to size the benefit to core earnings from the wider 3-month LIBOR versus repo spread in the quarter?

Yes. So the difference between 1 month and 3 month caused -- was a little bit of a detriment during the most recent quarter. It was -- yes, how much we think it was. But I think going forward, we expect that effect to moderate. So I mean, it was not more than $0.01 or $0.02 if I had to guess, and we don't have that broken out exactly how much that caused, but it was fairly minimal in terms of cents per share.

Got you. And then you guys -- are you guys still running like half and half 3 month versus 1 month in terms of your swaps, what they're pegged to?

It's approximately that. We've added more 1-month swaps recently. So it's more -- a little bit more skewed towards 1 month more recently.

Our next question comes from the line of Eric Hagen from Keefe, Bruyette & Woods.

Some of your -- one of your peers shared on their earnings call that book value was up in July. And I think that was mostly from appreciation on CMBS. I'm curious if you guys have witnessed the same thing so far in 3Q.

Yes. I mean -- this is Kevin Collins. I'd just jump in and say that CMBS has been a sector that's performed well and continue to see credit spread tightening. One of the things that John mentioned in his comments is that investor demand has been strong, and I think where it's been particularly strong.

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And I think it's a function of.

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fact that this is a.

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commercial real estate.

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originated in many cases several years ago. So they're benefiting from embedded property appreciation, and thus lower loan-to-value ratios today not to mention spread durations contracting.

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So that's been (inaudible) a subsector of (inaudible). And it's not too dissimilar from what you've seen in corporate is where you've seen them. (inaudible) corporates a little (inaudible) and that down in a (inaudible) structure.

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In CMBS, you've had an outperformance so we've been really pleased with that portion of our

(technical difficulty)

Needed to perform strong -- strongly going forward.

Yes. This is Dave Lyle. I'll add to that. I think yes, CMBS credit was probably the biggest outperformer in terms of spread compression early in this quarter. We did see some spread improvement on the residential side, residential credit side as well during the month of July. Spreads were -- in Q2, spreads and resi credit were generally slightly wider, especially in on-the-run-type paper. So most of our resi credit portfolio is more seasoned and spreads held in generally better there compared to the spread widening that we saw in the new issue market. But generally speaking, across both seasoned and new issue, some of the spread softness that we saw in Q2 was largely reversed through better valuations during the month of July.

Great. That's really helpful, really helpful answer. So I think you guys discussed last quarter some opportunities that you may have been seeing in the prime jumbo securitization market. Is that still something that looks reasonably attractive to you? And either way, I mean, maybe you can just kind of share where levered ROEs are in that segment, assuming that you're just kind of involved in looking at it generally.

Sure. I mean, from the CUSIP security perspective, levered ROEs have improved a little bit. We're seeing kind of high -- depending on financing terms, very high single digits to very low double digits on AAAs as financing terms have improved. That's a little bit of a higher levered trade. And with -- there hasn't been much softness in spreads further down the stack. But we've seen financing terms improve there as well, so that has benefited ROEs.

On the loan side, again, I think longer-term, we do intend to be involved in the loan market and loan trades and securitization. We want to make sure that the opportunity is accretive when we go down that path, and we've recently seen a lot of spread tightening in the loan market as it's got more competitive. In particular, there is a few very aggressive large buyers out there that I -- that get a lot of attention and have caused quite a bit of spread compression. So at this particular moment, I wouldn't see us making a large allocation there in the current environment. But that is a -- that's a business and a strategy that we expect to be involved in when the opportunity improves down the line.

Great. And then just on agency leverage, I mean, I feel like this is the broken-record question every quarter. But how are you thinking about that? I mean, and just kind of a housekeeping question. I mean, the leverage that you show in your press release, I assume that includes CMB -- Agency CMBS leverage. So just to tick down quarter-over-quarter, is that, A, because of the CMBS additions during the quarter? And B, just how are you thinking about the leverage in that segment overall more generally?

So I'll start with the second one first. Yes, I mean, at quarter-end, I mean, the Agency CMBS position was relatively small. So it wouldn't have been able to move the needle. But it's not terribly different than the rest of the agency book anyway. So it wouldn't have mattered even if that was bigger. So that's approximately the same. As far as like just leverage targets in that, we don't expect to change our leverage within agencies. Our overall leverage is more a function of our asset mix. So if you move a little bit more towards agencies, you'll see our overall leverage increase. But that's just more a function of mix rather than wanting to crank up leverage on agencies particularly.

We don't have any questions over the phone. (Operator Instructions)

Jeyard, if there are no further questions, I think perhaps we'll just conclude the call and thank everyone for participating and make sure everyone understands. As always, we are very happy to help. So if there are questions or clarifications that might be needed, please reach out and we'll be happy to help. Thanks, again, everyone, and we hope you have a great day.

Thank you, speakers. Participants, that concludes today's conference call. Thank you all for participating. You may now disconnect.