Q3 2019 Earnings Call

Mitch.

Welcome to Invesco mortgage capital Inc.'s third quarter 2019, Investor Conference call, All participants Liana listen only mode until the question and answer session at that time to ask a question first the star followed by the one on your telephone.

As a reminder, this call is being recorded and now I would like to turn the call over to Brendan Byrne, an investor Relations Mr. Burke you may begin.

Well, thank you and welcome to the Invesco mortgage capital third quarter 2018 earnings call management team and I are delighted you joined us and we look forward to sharing with you were prepared remarks that conducting a question and answer session before turning the call over to our CEO John Anzalone I wanted to provide a reminder that statements made in this conference call and the related presentation may include forward.

Which reflect management's expectations about future events and our overall plans and performance. These forward looking statements are made as of today and are not guarantees they involve risks uncertainties and assumptions and there can be no assurance that actual results will not differ materially from our expectations for.

For a discussion of these risks and uncertainties. Please see the rest describing their most recent annual report on Form 10-K , and subsequent filings with the FCC Invesco makes no obligation to update any forward looking statement. We may also discuss non-GAAP financial measures during today's call reconciliations of these non-GAAP financial measures may be found at the end of our earnings presentation.

Do you get a slide presentation today, you may access our website at Invesco mortgage capital Dot Com and click on the Q3 2019 earnings presentation link under Investor Relations again, welcome and thank you for joining US today I'll now turn the call over to John Anzalone John .

Good morning, and welcome to Ivy ours third quarter earnings call. Joining me on the call. This morning, our Brian Norris, our CIO, Kevin Collins, our president and head of commercial credit Lee Phegley, our CFO and Dave while our COO and head of residential credit.

I'm pleased to announce core earnings of 47 cents per share, which once again exceeded our 45 cents dividend our book value remains stable. Despite a relatively volatile backdrop, increasing six tenths of a percent to 16 31 per share.

The combination of our dividend and our increase in book value produced an economic return of 3.4% for the quarter, bringing our year to date economic return to 15.7%.

Our team achieved this performance despite another fairly tumultuous quarter in which we saw the 10 year trade in a 67 basis point band volatility increased across most asset classes and funding markets disruptive to the pointed the fed had to intervene.

Despite the turmoil turmoil I'd be our was able to raise another 290 million of capital during the quarter.

That capital was put to work quickly at accretive levels as we were able to invest the proceeds in late August when the agency market had just experienced a significant widening event as interest rates bottomed.

Before turning the call over to Brian I want to spend a few minutes explaining at a high level, how weve constructed I've yards portfolio in a way. It has resulted in book value stability, while producing a repeatable core earnings stream.

Over the course of the past year or so we have been deliberate and allocating capital to strategies that minimize our exposure prepayment risk as increased prepayments have detrimental impact on core earnings.

Over that period, our overall exposure to agency RMBS has been reduced and what we do own and agency RMBS is backed by collateral that in one way or another is less exposed to refinancing activity.

At the same time, we've steadily increased our exposure to agency CMBS.

These investments have several favorable attributes the main ones being that their credit is the credit is guaranteed by government agency their fixed rate invests easy to hedge and the benefit from notable prepayment protection.

They also have exhibited limited spread volatility relative to non guaranteed credit assets, which makes them very attractive to finance all of this makes him ideal candidates for inclusion in our portfolio.

We have generally avoided the agency RMBS GBA market, whereas we've seen recently the turns could be quite volatile.

These periods of volatility can often be persistent and difficult to forecast.

We have also largely avoided the MSR and I O market, where returns can often look attractive but are extremely dependent on prepayments remaining well behaved. We don't think it makes sense to double down on convexity risk in that market. When we spend so much time, avoiding it and the rest of our portfolio.

We have also been very active on the hedging side of our portfolio. We've adjusted our hedge book during the course of the year as the rate environment has changed our duration profile and as we have added capital through equity raises our goal is to keep our portfolio and thus book value well hedged against changes in interest rates and we've been quite successful.

In doing that I'll also point out this applies to both the long and short end of the interest rate curve.

Regarding the short end generally look to match the index rate of our swaps with the index rate of our repo to avoid basis risk between one and three month LIBOR. This ultimately helps create a more stable effective net interest margin.

Again, our objective on constructing the portfolio is to produce a repeatable core earnings stream, while keeping book value stable.

Looking forward, we believe that we're in we're very well positioned.

We see several tailwinds that should continue to be supportive of the positive trends we've produced in core earnings.

The fed has signaled that they're on hold and we've seen a steepening of the yield curve, which is supportive of future are always.

Volatility has fallen as Weve entered the fourth quarter and this of course is supportive of mortgage assets.

Fundamentals in both residential and commercial credit remains strong which supports our credit investments and perhaps most importantly prepayment speeds have likely piece with the recent October report as seasonal factors and higher rates impact borrowers. So overall, we see a very positive outlook for for the coming quarters.

Finally, I want to point out that we've simplified our management fee calculation starting in Q4 going forward will calculate our fee using our shareholders' equity, which will bring further alignment between shareholders in management details of this can be found in our recently filed Q.

With that I'll turn the call over to Brian .

Thanks, John and good morning, everyone on the call I'll start on slide six where we detail our sector allocations on an equity and asset basis.

As you can see in the pie charts on the left we remain well diversified across asset classes.

Actively managed hybrid strategy continues to provide stable book value and consistent core earnings despite a difficult third quarter and the financial markets as volatility increased.

The common equity raise in August provided an opportunity to capitalize on this volatility as we were able to add assets at attractive levels given spread widening in the first half of the month.

Proceeds were deployed primarily into agency CMBS and agency RMBS, increasing our overall allocation to agency assets to 76% as of September Thirtyth.

As John mentioned, the most significant change at our portfolio is the increased allocation to agency CMBS, which now represents 21% of total of total assets increased from 13% and the second quarter.

This increased allocation to agency CMBS is largely attributable to the August equity raise in addition to the reinvestment of Paydowns in sales from the agency RMBS allocation given that we viewed agency CMBS as a more attractive use of capital during the quarter as agency RMBS remained under pressure from the increase in interest rate.

Volatility and faster prepayment speeds.

Moving on to slide seven which details the composition of our agency RMBS assets.

Prepayment speeds on our holdings increased during the quarter, reflecting lower mortgage rates and higher seasonality negatively impacting the effective yield on our pass through securities by four basis points from 3.69% to 3.65%.

Positively our agency RMBS allocation is largely comprised of 30 year specified pools, which contain some level of prepayment protection and experienced CPR is 25% to 30% slower than the market on average.

The value of this protection continue to increase as interest rates fell improving approximately a quarter point on our 30 year specified pools during the quarter.

We believe october's prepayment speeds represent the near term peak for our holdings and thus we should see improvement on this front in the coming months in quarters, given more attractive valuations and improved financing are always on the sector have improved to 13% to 15%.

Turning to slide eight you can see in the lower left hand table that our allocation to agency CMBS has grown to nearly 5 billion. We purchased 1.9 billion of agency CMBS during the quarter predominantly in the Fannie Mae DUS program spreads widen modestly during the quarter, allowing us to add exposure at attractive valuations both during the difficult.

Deployment of our capital raise as well as the reinvestment a monthly cash flows for art from our agency RMBS holdings, the prepayment protection embedded in our holdings. In addition to muted spread volatility has played a large role in the reduction of our overall book value volatility and increases the consistency and repeatability of our core earnings.

Slide nine detailed our company's allocation to commercial credit our holdings continue to benefit from improved credit fundamentals and strong demand during the quarter led to modestly tighter spreads and book value gains. In addition, similar to agency CMBS. This portfolio benefits from notable prepayment protection, we were able to add one.

Hundred $40 million of recently issued non agency CMBS during the quarter with always in the low to mid teens.

Slide 10 highlights the credit quality of our commercial portfolio fundamentals in commercial real estate remain supportive, particularly given the season nature of our portfolio as property price appreciation since issuance reduces embedded leverage at our holdings. The chart on the left shows the seasoning of our CMBS assets, indicating roughly two thirds of our holdings.

Our originated five or more years ago, while the chart on the right highlights the strong credit performance of our holdings with 720 million benefiting from rating agency upgrades.

Slide 11 covers our residential credit portfolio. This portfolio remains well diversified as indicated in the Pie chart on the upper left spreads were mixed during the quarter as recent as you CRT spreads tightened while season CRT widened on faster prepayment speeds.

Credit fundamentals remain supportive here as wage growth and lower mortgage rates have improved affordability, we were able to add at 112 million in residential credit during the quarter as improved financing and increased issuance provided opportunities to add assets at attractive levels.

Slide 12 provide some detail around the credit quality of our residential credit portfolio, 62% of our CRT investments have been upgraded by at least one rating agency since issuance as shown on the chart on the left.

The upgrades are result of significant underlying home price appreciation and low default rates. The chart on the right reflects the vintage distribution of our investments work were approximately two thirds of our assets were issued prior to 2015 and benefit from the strong recovery in the housing market.

Lastly, slide 13 summarizes our financing and hedging at quarter end, we had 18.1 billion of repo outstanding was 34, Counterparties and $1.65 billion of secured financing through the federal home loan bank.

We have seen improve financing across our assets as repo spreads tightened and LIBOR declined positively we saw minimal impact from repo market turbulence. During September we intentionally stagger repo maturities. So only a small portion of our book had to be role. During this period and we limited the tenor of those roles given our view that the market would quickly stabilize.

To reduce the risk associated with changes in repo funding cost. We held 14.4 billion notional of interest rate swaps, an increase of nearly 2 billion quarter over quarter as our portfolio grew.

In closing, we're very pleased with the performance of our company year to date and believe the actions. We've taken will continue to produce a stable book value and attractive core earnings stream that is repeatable across numerous market environments, given the steepening of the yield curve since quarter end at the Federal reserve that expressed a high bar for further action, we believe the current and.

Harman is very attractive both for the performance of our current assets as wells for potential investment opportunities in our target asset classes.

That ends my prepared remarks, now we will open the line for today.

Thank you and at this time, if you would like to ask a question. Please press star one.

Our first question today is from Eric Hagen from KBW.

Hey, guys, Thanks nice quarter.

Just a couple of housekeeping items for me I think.

The press release noted the effective yield on agency CMBS was 344 for the period in the presentation.

The period ending yield on on the DUS bonds, which are your largest position were to 80 cents to the market really tightened that much during the quarter or was there some timing related impact when you guys raise capital deployed it I'm just trying to square thanks.

Yeah, Eric this is Kevin much of that is timing related.

In fact that would say that.

Agency CMBS spreads actually widened the touch over the quarter.

And during the time of the capital raise we were able to take those proceeds and invested.

More attractive levels.

Okay.

Alright, great.

And then it looks like there was a bit of rebalancing the period in the swap portfolio. If you guys touched on it.

In your remarks, you guys lumped in lower pay rates, which I think is really good to see I'm just curious on the timing impact of that too I mean when.

When did that take place and how much of the quarter's earnings are reflective of that that rebalancing.

Yeah, Eric This is Brian I mean, we did a lot of that rebalancing kind of throughout the quarter I mean, some of it certainly was during the August capital raise as we were adding swaps at lower levels at that time.

But as we add agency CMBS the duration of those are significantly longer than.

The bonds that were replacing it with so agency RMBS or much shorter so we've been adjusting our hedges to account for that.

Okay, Yes to your point on that the duration can you just give us a sense for your duration gap at the end of the quarter I mean.

I know the in the past you guys.

Articulated they don't really look at the portfolio on a duration gap standpoint.

Any clarity there.

I.

I would be helpful.

Yeah, Hey, Eric and his Sean I mean, we try to keep our AR.

Empirical duration as close to zero is we can.

So I mean, that's kind of how we look at it. So I mean, you can back out that if we do that than our.

Duration gap would effectively be close to zero also.

So I mean, that's that's what we've experienced lately our model duration is a little bit longer than that but I think empirical is the one we look at more closely and is more.

More relevant.

Okay.

And can you give us a sense for book values since quarter end.

Yes down a little bit less than 1%.

Hi, guys. Thank you very much.

Thank you and as a reminder, if you would like to ask a question. Please press star one and our next question is from Trevor Cranston.

Jay PM Securities.

Hey, Thanks, good morning.

Couple of questions on the agency CMBS books, and just you know you guys continuing to allocate capital there.

I guess wondering when I listen to you describe why are you find that sector attractive the lack of convexity risk.

Relatively low spread volatility.

It seems like a strategy that would support using higher levels of leverage versus agency RMBS or certainly credit.

So I guess I was a little surprised to see leverage not really change much this quarter as you go out into the agency CMBS.

Can you talk about how you guys are or looking at overall leverage as is the position grows and specifically how much you're willing to lever the agency CMBS book. Thanks.

Hey, Thanks, Trevor Yeah. This is Bryan again.

Yeah, Yeah, our a our leverage overall on the portfolio was was marginally down quarter over quarter and and really the agency CMBS book has been largely replacing agency RMBS, which we lever about the same.

So it's really.

No no change in leverage between those two sectors.

Okay got you and then I think I heard in the prepared remarks, I think you guys said.

Returns and agency RMBS were low to mid teens currently I missed it if you said, where where you're seeing always on the agency CMBS.

Comment on that settles meaningful thanks.

Sure. This is Kevin in terms of non agency CMBS, we're in the low double digit or are we territory at this point.

For inferred unskilled excuse me for agency CMBS to clarify.

Okay.

Perfect.

And then one follow up question on the adjustments made to the swap portfolio do you have the weighted average maturity of the swap book as of September Thirtyth.

I do not have that in front of maybe we can get that too.

Okay.

Thank you appreciate the comments.

Im showing no further questions at this time, just turn the call back to John Anzalone.

Okay, well, thanks, everyone for joining us and we look forward to seeing you again next quarter. Thanks.

Thank you and this does conclude today's conference you may disconnect at this time.