Q4 2019 Earnings Call
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Welcome to Invesco mortgage capital Inc.'s fourth quarter 2019, Investor Conference call, all participants will be in a listen only mode until the question and answer session.
That time to ask a question.
Please press the star followed by the one on your telephone as a reminder, this call is being recorded no I would like to turn the call over to Brandenburg and Investor Relations Mr. Bert you may begin the call.
Well, thank you and welcome to the Invesco mortgage capital fourth quarter 2018 earnings call the management team and our delighted you've joined US and we look forward to sharing with you our prepared remarks to conducting a question and answer session before turning the call over to our CEO John Anzalone I wanted to provide reminder, that statements made in this conference call and the related presentation may include forward looking statements.
Which reflect management's expectations about future events in our overall plant. The performance. These forward looking statements are made as of today and are not guarantees they involve risks uncertainties and assumptions in there could be no assurance that actual results will not differ materially from our expectation for a discussion of these risks and uncertainties. Please see the rest described in our most recent annual report on form 10.
Okay and subsequent filings with the SEC, that's going make no obligation to update any forward looking statement 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 to be the slide presentation. Today, you may access our website at Invesco mortgage capital Dot com and click on the Q.
For 2018 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 fourth quarter earnings call I'll be joined on this call. This morning by 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.
We're pleased to announce core earnings for the fourth quarter, a 52 cents per share an increase of five cents from the third quarter as the portfolio has benefited from a full quarter of earnings power and generated by the August capital raise as well as a lower effective cost of funds.
The increase in core earnings allowed us to raise our common dividends for the quarter by 11% to 50 cents per share once again, our book value remains stable ending the quarter relatively unchanged at 16 29, the combination of our increased dividend and our steady book value produced an economic return of 2.9%.
The quarter.
Well, we produced strong results for the fourth quarter I want to spend a few moments highlighting ivy ours achievements for the full year 2019 was a stellar year for Ivy our stockholders as we increased our dividend, 19% from 42 cents to 50 cents per share and improved booked value nearly 7% from 15 27 to 16.
29, delivering an economic return of 18.8%.
We also raised over 500 million of equity capital during the year, which allowed us to increase scale and invest in additional accretive assets.
As always active management was a key to our success and we were quite active with respect to our investment portfolio as well as our interest rate hedges during the year.
On the investment side, we continue to be deliberate and allocating capital to strategies that minimize our exposure to prepayment risk as it has increased prepayments have a detrimental impact on core earnings.
Over 2019, we reduced our allocation to agency RMBS and the assets. We continue to hold in this sector are backed by collateral that is less exposed to refinancing activity.
At the same time, we've steadily increased our agency CMBS physician, which constituted 60% of our equity in 22% of our assets at year end.
Agency CMBS has several favorable attributes and is guaranteed by government agency, which limits spread volatility and allows us to finance them at attractive levels and they are fixed rate with notable prepayment protection and thus more efficient to hedge the combination of attractive financing and efficient hedging makes agency CMBS a complimentary asset.
Class for our portfolio.
Although we are less active in the non agency residential and commercial sectors. During 2019, we modestly increased our credit investments through selective additions of accretive assets through the year.
In total we purchased 422 million of subordinate CMBS and 340 million of residential credit assets during the year.
Positively the credit bonds, we own continue to benefit from structural and deleveraging and stable fundamentals and we're well positioned to take advantage of these sectors when new purchases are attractive.
We also actively managed our hedge portfolio throughout 2019, as our duration profile reacted to the volatile interest rate environment, and the and the deployment of new capital.
We are able to take advantage of the significant decline in swap rates during the year to dramatically improve our effective cost of funds.
Our efforts to minimize our exposure to the basis for June one in three month LIBOR on our borrowings and interest rate swaps largely insulated earnings from shifts in the LIBOR curve over.
Overall, we have been quite successful and utilizing hedges to protect book value and improve our effective interest rate margin, despite a volatile year and interest rates.
Again, our objective and constructing the portfolio is reserve or improve our core earnings stream, while maintaining a stable book value.
Looking forward, we believe that we are very well positioned to continue the positive momentum we established in 2019.
In fact, I view has had a very good start to 2020 as we successfully raised 347 million in common stock earlier, this month, which we've already invested into accretive assets book value. Since year end is up four to half for said as agency CMBS in credit assets continue to be very well bid so okay.
Overall, we see a very positive outlook for the coming quarters and feel very good hard.
Feel very good about our ability to continue producing results that are reliably among the best in the mortgage REIT sector with that I'll turn it over to Brian.
Thanks, John and good morning to everyone on the call I'll start on slide six where we detail our sector allocations on an equity and asset basis as detailed in the pie charts on the left we remain well diversified across asset classes are actively manage hybrid strategy continues to provide a stable book value and attractive core earnings and what proved to be a volatile year in the fixed income.
Markets the common equity raise in August 2019 provide an opportunity to capitalize on this volatility and our strong core earnings in the fourth quarter reflect a full quarter of those new investments our asset allocation remain largely unchanged on the quarter with a slight reduction in our agency RMBS holdings to fund purchases and agency and non.
Agency CMBS or activity in the fourth quarter was primarily on the hedging front as we extended hedges to lock in low rates for longer and to more effectively offset our exposure is an agency CMBS and the extension of our agency RMBS and a modest bear steepener in interest rates.
As mentioned by John We've had a strong start to this year and the common equity raise in February reinforced our ability to capitalize on market opportunities as we were able to quickly deploy proceeds into agency RMBS given attractive valuations following spread widening in January.
Moving on to slide seven which details the composition of our agency RMBS assets prepayment speeds on our holdings increased during the quarter as low mortgage rates in the second half of 2019 led to an increase in refinancings.
Positively our reduced allocation to agency RMBS sector mitigated the overall impact a faster prepayment speeds to core earnings our agency RMBS allocation is now 52% of total assets and remains 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.
Despite higher interest rates during the quarter the value of this protection was largely unchanged as demand remains robust given continued challenges in the TBA market.
Agency RMBS performed very well in the fourth quarter as attractive valuations higher rates steeper yield curve and lower volatility all combined to produce a beneficial environment for the sector.
Turning to slide eight you can see in the lower left hand table that our allocation to agency CMBS remained steady at nearly 5 billion EUR, 22% total assets asset spreads were stable during the quarter, but spread tightening through the end of the third quarter made additional accretive investments challenging to source, we remain positive on the sector.
And we'll look to increase exposure as valuations become more attractive given the prepayment protection on these holdings, we've been able to lock in an attractive net interest margin on nearly 5 billion of assets that should benefit the portfolio for the life of the investments.
Slide nine details our company's allocation the commercial mortgage credit.
Our holdings continue to benefit from improved credit fundamentals and similar to agency CMBS. This portfolio benefits from notable prepayment protection, we were able to add $19 million of recently issued non agency CMBS during the quarter with always in the low to mid teens as continued spread tightening in the sector provided few opportunities for accretive investments.
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Slide 10 highlights the court credit quality of our commercial mortgage portfolio fundamentals and commercial real estate remains supportive, particularly given the seasonal nature of our portfolio as property price appreciation since issuance reduces embedded leverage in our holdings.
The chart on the left shows the seasoning of our CMBS assets, indicating roughly two thirds of our holdings were originated more than five years ago. While the chart on the right highlights the strong credit performance of our holdings with over 700 million benefiting from rating agency upgrades.
Moving on to slide 11, which covers our residential credit portfolio. This portfolio remains well diversified as indicated in the Pie chart on the left.
Credit fundamentals are supportive here as wage growth and lower mortgage rates have improved affordability, we were able to add 33 million in residential credit during the quarter strong fundamentals in the sector drive valuations higher limiting our ability to add accretive investments.
Slide 12 provide some detail around the credit quality of our residential credit portfolio.
63% 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, indicating over 60% 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 year end, we had 17 and a half billion of repo outstanding with 33, 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 to reduce the.
Risk associated with changes in repo funding costs, we held 14 billion of notional of interest rate swaps, a decline of 425 million quarter over quarter. The decrease in notional amount was largely due to the reduction in assets given modest deleveraging during the quarter.
The lower average fund average cost of funds can be attributed to the decline in LIBOR as well as the active management of our interest rate swaps potential volatility in the year end fund funding markets was largely avoided as we locked in longer maturity repo. Shortly after the FOMC meeting in October which was the final fed funds interest rate cut of the year.
In closing with a 2019 economic return of 18.8% and a total return on common equity of 29% our performance for the year was among the best in the industry. We remain focused on providing an attractive dividend supported by core earnings and stable book value and believe we are well positioned to benefit from the current mark.
That environment, we appreciate the support from our investors and are excited about opportunities in 2020.
That ends my prepared remarks, and now we will open the line for QNX.
Thank you I will now begin the question and answer session. As a reminder, if you would like to ask your question. Please press star one to withdraw. Your question. You May proceed to once again. This time, if you will like to ask a question. Please press star one.
Our first question is from Doug Harter with Credit Suisse. Your line is open.
Thanks can you talk about the the relative return characteristics of.
Currency CMBS.
Kind of where you see spreads.
Are we on that compared to the agency RMBS just to understand kind of the different profiles are.
Sure Doug This is Brian.
Agency RMBS is generally aro ease around 13% to 14% with agency CMBS.
Maybe 200 basis points behind that and the low double digits area.
Leverage on both of those asset causes are pretty similar we get similar financing on repo there so leverages going to be in the nine to 10 range 10 times on that.
And I guess is that 200 basis points back is that factoring in kind of the strong move I guess you've seen in.
The first the first quarter, so I guess that's.
Those returns probably were more comparable before before kind of the first.
That's right when we are more aggressive adding agency CMBS.
Back in and kind of middle in late 2019, those are always were kind of on top of each other.
And then I guess, just with that I guess, how do you see the attractiveness of sort of continuing to hold it kind of given the strong move you've already captured versus the less volatility that you mentioned I guess.
Trade off today.
Sure we.
We'll certainly continue to hold it we've been able to lock in the NIM on those holdings that we've already purchased so.
No we like the kind of dependable steady stream of earnings at that provides the portfolio. So.
In the agency RMBS.
As you know as I mentioned, it is a little bit more attractive right now but.
Certainly given the increased convexity risk that we see in those holdings.
It's a bit of a balancing act.
We'd like to add a little bit more agency CMBS, if we can see a little bit better valuations there.
Great. Thank you.
Next question is from Eric Hagen with KBW. Your line is open.
Thanks. Good morning, guys, just just kind of following up on the relative value conversation I mean rates have already come down a lot this year and the MBA refi index, just had a multi year high.
I'm just curious how you guys are thinking more holistically kind of longer term about your approach to prepayment risks and the relative value of being an agency RMBS where.
The premiums on most of those securities have increased pretty meaningfully.
But the yield on look into liquidity are higher than they are in agency dust market, where the prepaid risk because obviously lower but you don't have the same way.
Entity.
It was also lower so just how do you kind of think.
You address kind of the current market but.
More holistically just from a risk management standpoint, where rates are today, just curious what you think about that tradeoff. Thank you.
Yes, that's exactly right. Eric This is Bryan again, certainly given where the refi index as right is right now we expect speeds to increase.
Pretty meaningfully over the next few months it hasn't really started yet and that matter of fact leasing.
Slower speeds, so far this quarter, but.
Moving forward, we'd like to be well diversified.
And that includes in the credit assets as well we.
We're at 52% of total assets and agency RMBS. So we think thats a fairly.
Manageable amount of kind of convexity risk from that perspective.
Certainly relative to the rest of our holdings that.
Certainly mitigate that risks. So we're we're pretty comfortable with where we are right now and like I mentioned that agency RMBS number will.
Trend up modestly just given the equity raise that we just.
Deployed into agency RMBS.
Okay.
Great. Thank you for that answer and then just looks like the funding basis, the receive rate on swaps relative to repo funding rates.
Has tightened a bit over the last few weeks against the depends though on.
The receive rate.
He is on your swaps can you guys just give us.
A break down again.
How you what percentage of your swaps or three month LIBOR as the receive rate versus one month LIBOR.
Sure.
As of 12 31, we were about 24% three month LIBOR.
And given the swaps that we've added so far this year that has trended down to about 16%.
Of three month LIBOR.
Total notional so.
Yes.
We've we've seen LIBOR rates come down so the spread between.
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What we're receiving versus what we're paying has has come in a little bit.
Okay, and then the remainder of that.
Of that breakdown is one month LIBOR rate I had to be done, but just yet.
Okay.
Exactly exactly right yep okay.
Okay. Thank you very much.
Our next question is from Trevor Cranston with JP JMP Securities. Your line is open.
Hey, thanks.
On the book value change you guys mentioned that's occurred so far.
2020.
Can you say if any of that was due to.
Having positive net duration in the portfolio or if it was kind of more purely related to spread tightening.
And related to that can you also just maybe talk generally about how you guys are currently.
Bridging penetration portfolio and rich right, Yeah, I would say, yes. It was a bit of both in terms of first quarter. I mean, you agency CMBS is has had a very good start to the year. So I mean, clearly that we benefited from that.
Other spread.
Non agency spreads have also.
Tighten during the quarter.
And with the duration gap.
Good question.
We tend to run a arm our empirical duration has tended to be very stable. So our book value has been relatively stable over the course of the last year.
And.
Part of trying to balance that is you've got credit assets and.
And our youre going to react one way to interest rates as interest rates fall credit assets tend to widen. So we always tend to run somewhat of a longer duration gap model wise to offset that and that's true now in was true has been true. So far this year. So we did.
Benefit a little bit from having a longer duration gap.
Because it's not usual you have spreads tightening and rates falling at the same time. So we did benefit from from both sides of that were throughout 2019. It was more normal where were and that was almost completely offset and we didnt see much book value movement at all.
Okay got you that's helpful.
And then.
Looking at the the funding slide on page 13 of the deck.
It looks like the particularly the non agency portfolio at a pretty.
Significant drop in cost of funds.
During the fourth quarter I was curious if there was anything notable you guys are seeing on that side of the book in terms of.
Like traders tighter spreads on on the funding for non agencies cures or or if it was more so just related to lower level roots. Thanks.
Hey, Trevor this is Dave while.
Yes, most of that was was definitely lower LIBOR, but there is a component that is resulting from just the further improvement in the credit quality of our assets.
As they continue to season as we're seeing rating upgrades.
And as we continue to see our repo counterparties be very competitive in terms of wanting to provide us with funding.
We're seeing seeing benefits on the on repo spread side as well.
Okay makes sense. Thank you.
At this time I'm showing no further questions.
Alright, well. Thank you everybody for joining us and we look forward to talking to you in may.
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