Q3 2020 Invesco Mortgage Capital Inc Earnings Call
Welcome to Invesco mortgage capital <unk> third quarter, 2020, <unk> Investor Conference call.
All participants will be in listen only mode until the question and answer session.
Time to ask a question. Please press star followed by the one on your telephone agile.
As a reminder, today's call is being recorded.
Now I would like to turn the call over to Jack Spade and Investor Relations Mr. Bateman you may begin the call. Thank you.
Thank you and welcome to the Invesco mortgage capital third quarter 2020 earnings call. The management team and I are delighted you joined us and we look forward to sharing with you our prepared remarks and conducting a question and answer session.
Before turning the call over to our CEO, John Anzalone I wanted to provide an 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 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 discussion of these risks and uncertainties.
Please see the risks described in our most recent annual report on form 10-K, and subsequent filings with the FCC Invesco make 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.
And view the slide presentation today, you may access our website at Invesco mortgage capital Dot Com and click on the Q3 2020 <unk> earnings presentation link under Investor Relations again, welcome and thank you for joining us today.
I'll now turn the call over to John.
Hi, good morning, and welcome to Invesco mortgage capital <unk> quarter earnings call I'll give some brief comments before turning the call over to our Chief investment Officer, Brian Norris to discuss the current portfolio in more detail.
Your tumultuous start to the year brought on by the impact of the close of 19 pandemic the financial markets continue to recover during the third quarter I'd I'd be are you have made tremendous progress in implementing our agency MBS focused strategy and opportunistically, reducing our exposure to credit assets.
In the quarter core earnings came in at six cents per share exceeding our recently increased dividend by chance.
He was $3 or 47 cents a quarter end, which represents an increase of about 9% for the quarter.
The combination of the increased dividend and our book value appreciation produced an economic return of 11% for the quarter.
The improvement in book value has continued since quarter end as we estimate that book value is up approximately 6% since quarter end through last Friday.
The results of our activity can be seen on slide three of the presentation.
During the quarter, we purchased 5.6 billion in specified pool agencies and invested an additional 900 million and agency TB age.
This brought our allocation to agency mortgages up to 93% of assets, it's 60% of equity.
We also reduced our credit exposure significantly selling 1.1 billion a credit assets, while repaying the remaining balance of our secured bonds that were collateralized by credit. This leaves us with a notably smaller credit portfolio that is completely unencumbered.
As you look out over the next several quarters. Our outlook is quite constructive we have continued to make progress in reallocating the portfolio. During October as additional credit sales combined with agency investments will continue to prove to improve our earnings power.
Remained positive and agency mortgages as we expect demand from the federal reserve and commercial banks to remain strong.
The economic outlook remains uncertain, we expect the feds remains supported by continuing large scale asset purchases and by keeping short term interest rates low teens for the foreseeable future.
Post election, we expect interest rate volatility to remain subdued which is also supportive of agency mortgage assets.
Increased levels of prepayments remain a potential headwind, but our focus on purchasing specified pool collateral helps to mitigate that risk.
I'll stop here and let Brian go through the portfolio.
Yeah, Thanks, John and good morning, and thank you.
The call I'll begin on slide four which summarizes our agency RMBS assets and trading activity during third quarter consistent with the strategic transition we communicated since June <unk>.
Purchased 5.6 billion of agency RMBS specified pools during the quarter.
Strong demand for our credit assets provided.
Opportunities for dispositions at attractive prices freeing up capital for allocation to the agency focused strategy.
As detailed on the chart on the top left.
Able to source attractively priced new issue collateral stories, including loan balances low FICO LTV.
LTV and geopolitical which consists exclusively of borrowers and slower paying states, such as New York, Florida and Texas.
We also focus since a significant portion of our purchases on new production pools originated and serviced exclusively by banks in order to mitigate our exposure to pay up premiums while benefiting from improved prepayment protection.
That's a non bank originators and Servicers well.
Well pay ups on our specified pool holdings range from less than a quarter point to up to four points. The weighted average pay up on our portfolio is approximately one in a quarter points, representing approximately $70 million of market value at quarter end.
We believe low mortgage rates and historically fast prepayment speeds should continue to keep pay up premiums near current levels strong demand for prepayment protection supports valuations.
All purchases in the quarter consisted of 30 year collateral with coupons, ranging from 1.5% to 3% with the majority into than two and a half as indicated in the chart on the bottom left.
Even though our expectation for continued pressure on prepayment speeds at mortgage rates fell to all time lows, we focused our purchases on lower coupon pools, which typically experienced slower prepayments due to lower mortgage rates on the underlying loans and benefit from lower purchase prices, which reduces the negative impact of prepayments.
In addition, these coupons have been targeted by the federal reserve as a part of their bond purchase program valuations also benefit from positive supply and demand technicals.
Our specified pools paid only 1.8 CPR during the quarter reflective of the focus a newly issued lower coupon pools, given mortgage loans tend to pay slowly in the months immediately after.
After closing.
For prepayments typically begins to ramp higher around lunch six this.
This dynamic benefited the performance of our agency RMBS pools during the quarter as the weighted average yield was an impressive 1.91%.
The prepayment protection and our specified pools and active management should lessen the impact of faster prepayment speeds due to further seasoning of our holdings in the months ahead.
In addition, we added 900 million notional and agency GBA contracts, given the attractive implied financing rates and hedged carry available in the forward market for agency RMBS due to the significant demand from the federal reserve and commercial banks for lower coupon pools.
Given the current attract the attractiveness of certain CB eight contracts due to this favorable technical environment, we expect our investments in agency TBA grow commensurate with the growth in our overall assets as we continued to implement our agency focused strategy.
Turning to slide five and as John mentioned, we made significant progress in reducing our credit exposure during the quarter the.
Demand for our credit assets was robust and the notable improvement in valuations drove the majority of our book of our gain in book value.
In particular higher quality CMBS was the beneficiary of the June launch of the TALF program as spreads tightened dramatically in the AAA and double a rated assets we financed at the federal home loan bank through our captive insurance subsidiary.
Substantial credit dispositions at attractive valuations allowed us to pay off for a secured loan.
They'll be in August and redeploy capital into agency RMBS investments.
Further improved the earnings power of the portfolio, allowing us to increase our third quarter dividend to five cents.
Slide five details the seasoning and junior capital structure positioning of our remaining credit investments as of September Thirtyth.
As shown in the chart on the left our credit assets consist of predominantly season, the investments with over 80% of our holdings issued prior to 2015.
In addition to the benefits of seasoning, given the improvement in property valuations over the past five years.
Our CMBS credit holdings also benefit from substantial credit enhancement as detailed in the chart on the right with over 82% of our holdings, maintaining at least 10% of credit support.
In addition, 69% of our remaining credit investments are rated single a or higher.
We've been encouraged by the renewed investment demand for CMBS, which has led the spread tightening and contributed the book value appreciation.
The pace of spread tightening slowed over recent weeks, however, as increasing concerns related to the COVID-19 pandemic combined with heavy focus on the U.S. election.
To dampen investor demand.
We believe yesterday positive announcements regarding the timing and efficacy of the vaccine should prove beneficial for our credit holdings as the global economy continues to navigate the pandemic.
Regardless of near term headlines, we believe our bonds are well positioned for long term incremental spread tightening given the notable subordination detailed on slide five and favorable supply and demand dynamics.
Slide six details the growth of our funding and hedge book during the third quarter as shown in the chart on the upper left.
After paying off our secured loans at the FHLB in August all of our remaining credit holdings were held on an unlevered basis.
Eliminating the mark to markets funding risk on that portion of our book.
Repurchase agreements collateralized by agency RMBS grew to 5.2 billion as of September September Thirtyth.
And hedges associated with those borrowings also grew during the quarter to 4.6 billion notional of fixed to floating interest rate swaps.
Interest rates on our borrowings drifted lower during the quarter that settled in near 0.2%.
We took advantage of historically low interest rates further out that yield curves to lock in low funding cost field longer maturity interest rate swaps.
Given the potential for a steepening yield curve as the federal reserve keeps short term rates anchored for the foreseeable future.
Our economic leverage when including TV, a exposure increased to 5.1 times debt to equity as of September thirtyth, indicating significant progress toward the <unk> towards the transition to the agency focused strategy.
Given the notable changes in the portfolio since quarter end.
Well I'd seven summarize the progress we made in continuing to transition the portfolio through the end of October.
Demand for our credit assets continue during the month as we were successful in disposing of $112 million of credit exposure at attractive valuations.
These sales provided further opportunities to continue the ramp in agency RMBS as we purchased 1 billion of specified pools, and an additional 300 million notional and agent GTB eight contracts.
Bringing our total to six and a half billion of tools and $1.2 billion of <unk>.
Our borrowings and hedging grew commensurate with these purchases with repurchase agreements of $6.2 billion hedged with 5.2 billion notional of interest rate swaps at month end.
As noted on slide seven our liquidity position remains substantial with 351 million of Unlevered credit investments. In addition to 340 million of unrestricted cash.
Binding to represent approximately 8.5% of our investment portfolio.
To conclude our prepared remarks, we've been very pleased with the transition of the portfolio and our ability to restore a meaningful dividends for our investors and believe we are well positioned to continue to benefit from the current market environment.
The agency RMBS market continues to be well supported by the Federal Reserve purchase program as well as significant commercial bank demand in our credit assets continue to recover from the impact of the COVID-19, pandemic and marches liquidity crisis.
While the prepayment environment and agency RMBS remains challenging we believe our careful selection of prepayment protection and the active management will mitigate the negative impact of what has become a highly efficient process for mortgage loan refinancings.
Lastly, monetary policy remains very supportive and we expect that to continue well into 2021 as the federal reserve communicates a desire to maintain an accommodative stance over the medium term.
Thank you for you for your continued support for Invesco mortgage capital and now we will open the line for <unk>.
Our first question will come from Doug Harter with credit Susie Your line is now open.
Oh, Thanks, I'm, hoping you could just give a little more.
Color behind the fourth quarter book value move you know kind of how you would see that between credit and agency and then just also Directionally you know obviously some big moves yesterday, you know kind of if that was kind of a further positive to book value.
Yeah, Hey, Doug This is Brian I can I can start with that one and you know I think for the for the month of October and here in the first nine days of November.
Agencies, particularly lower coupon agency mortgages have performed pretty.
Pretty well so.
We do think that a good portion of the increase that John mentioned.
You know the up 6% or Friday is related to mortgages agency mortgages, but.
But our credit investments continued to trade.
Pretty well and hang in there. So I think you know that there could be a small bit of.
Those as well, it's just that you know were as as we reduce that credit portfolio. It becomes.
Less of an impact on the portfolio obviously.
Yeah, and yesterday yesterday mortgages actually held in really well. So we don't have you know we don't have a number for that quite yet, but we believe that you know given that mortgages performed pretty well and to yesterday's backup and they're performing pretty well. This morning as well. So we don't we don't think that that number would change.
Dramatically.
Yes. This is Kevin in for additional contracts you know that as you pointed out the positive news of the vaccine is that's certainly reenergized interest in our sector.
So we saw some positive price action and in CBX and not cash bonds to be clear I'm, a little too early to forecast the magnitude and cash bonds. Since the news is so for us, but just early indications and as you know we're seeing a cold subways CMBS five to 15 tighter single ways maybe.
20 to 30 tighter in trouble.
Somewhere around 40 to 75 basis points tighter, but again, that's all I'm you.
You know based on on very limited data since the news.
Really just.
And then I guess, just you know if those were to be you know if those were to translate to cash prices you know how might that influence your your timing for the disposition of the of the remainder of the credit portfolio and rotation into agency.
Yep.
Brian again, I'll cover that Kevin feel free to chime in that.
You know our portfolio of credit asset now is just a little over 300 million and through the end of through the end of October. So you know our goal is to continue to to reduce that you know we don't have.
Any liquidity reasons to do that you know immediately so we're going to take a measured pace and see where things shake out like Kevin said, it's been a little too early to really translate these recent moves into into a you know price performance for for CMBS assets.
But you know our goal over the next you know.
Few months is to continue to reduce those assets at the pace that we've seen over the last month or so.
Great. Thank you.
And our next question will come from Trevor Cranston with JMP Securities. Your line is now open.
All right. Thanks [noise].
You guys mentioned briefly in the prepared remarks, the food the yield on new pools, you bought was benefiting from very very low CPR as those are still pretty early in the season.
Can you say sort of where you would expect that the yield to shake out once once those are sort of fully ramped and you know over six months old relative to the one nine do you want and you will just show up for <unk>.
Yeah sure Trevor this is Bryan good morning.
Yeah, we are.
You know the portfolio paid five CPR last month. So you know we had started to see that ramp up.
The the yield to maturities on the bonds that were buying or had been in the 1.5% range and so we would expect that that will 0.9 to come down but again, that's that's assuming you know obviously, a static portfolio and and you know at <unk>.
You know the rate levels that we purchase them at so you know things things, obviously, we'll be changing as we move forward here, but oh, yeah Oh.
I would call it around 1.5% currently on new purchase.
For yield to maturities.
Okay got it.
And then thinking about the earnings impact of the portfolio rotation and the agency purchases in Threeq you.
Looking at slide six it looks like there was a.
Due to increase in repo in September do that.
Does that imply that a significant amount of the agency MBS purchases in Threeq you occurred in September or is there's probably.
Difference between when they.
Since we bought the repos little.
So slide six on the financing and hedging I'm, sorry, you said that the the repo.
Yeah. The increase in the repo balances from August to September I was wondering if that also implies that a lot of agency purchases occurred in September.
Oh sure yet so I believe last quarter, we had updated through July and we have made a decent amount of progress through the end of July.
Of of a couple of billion. So the other you know where you were at five and a half billion. So the other three and a half billion were purchased in August and September I believe that a decent amount of that was in September as August was was a little bit more quiet, but yeah, we've been pretty consistent you know it.
The timing of our agency purchases tends to correlate with the timing of our credit asset sales.
So as we find opportunities to sell those assets and that's when we redeploy those those proceeds into agencies.
Got it okay that helps.
Then last question <unk>.
Last quarter, we talked a little bit of votes euros exploring ways to optimize the capital structure.
Can you give any update on that and if you you know continue to evaluate things like preferred share strangers or preferred buybacks.
And how you're thinking about there currently thanks.
Yeah. This is John yes, so yeah, I mean, we're continuing to evaluate that I think our our goal was to you know first you know reallocate and portfolio and get a more normalized earnings stream and you know have.
A little bit more clarity for investors in terms of where our.
Our dividends are going to be.
And so I think we're well on the path. There. So we continue to evaluate either exchanges more likely or buybacks and yeah I think as we see.
He book value improvement you know.
Obviously, as okay, and trees, and hopefully [laughter] commensurate with that will be a improvement in the price to book at that gives us a lot more flexibility.
On the capital side, you know that that are retreating the more flexibility. So yes. So we continue to evaluate that and that's that's going to be a focus in the next couple of quarters.
Okay. Appreciate the color. Thank you.
And as a reminder, if you'd like to ask a question you May press star one.
Our next question will come from Jason Stewart from Jones trading your line is now open.
Thanks, Good morning, I'm can you give us an update on the d. It the way you allocate between spec pools, and PVA and if theres a limitation on the whole pool requirements till now that's keeping you from allocating more towards <unk>.
<unk>.
Yeah, Good morning, Jason It's Brian.
You know, what we're well past the requirement for whole pools, you know we use you know the <unk>.
Vast majority of our purchases since the beginning of July have been hopefuls. So you know the 55 per cent testers, where we're <unk> well beyond that so the limitation on TV a is not.
It's not related to that it's more you know, we expect that to kind of be in the 15% to 20% range of total assets and it's more because.
You know the attractiveness of TB, it tends to be a little bit or transitory. So we don't want to you know.
Depend too much on drop income to drive or our earnings for any particular quarter.
Okay that makes sense and then you have one commercial loan I think is fair valued at about 22 million could you give us the par amount I think it matures in early 2021, maybe February and what your plans are slashed discussions with their with regard to that one.
Yeah. This is Kevin I don't have the.
Financials would be exact them out in front of me now, but it's around 20 million and should be in our financials.
Okay, and then I'm guessing that you know extensions are on the table as that comes up on I don't know if you could give any details on the particulars of the lung would be helpful.
Yeah, So that particular loan is a commercial.
Commercial real estate business.
<unk>.
You know we extended to a hotel property you know at this point interest payments.
Payments on the loan or curve and you know obviously, given the backdrop with Ur Cobot Knight team. It's an asset that were monitoring closely but feel really good about the the sponsorship in the long term viability of the asset.
Okay. That's incredibly helpful. Thank you.
And just as a reminder, if you'd like to ask a question you May press Star one again to ask a question timeline one moment. Please to see if we get additional questions. Thank you.
And I'm currently showing that our next question will be from Derek Hewett with Bank of America. Your line is now open.
Hi, Good morning, everyone does yesterday's vaccine announcement impact that the pace of credit asset sales and then redeploying that capital into a.
And the agency focused strategy at this point.
Hey, good morning, yet you know this is Brian.
I think that you know as Kevin mentioned, we did see.
MBX tightened quite a bit yes.
Today, we haven't seen a lot of color.
Polar yet on on cash bonds, and where they're trading you know I think that.
You know.
Certainly news of the vaccine is positive and we do expect spread tightening to occur.
Off of off of that positive news, but you know.
Our pace of selling.
We'll we'll likely continue you know.
At its at its current level or at least you know near near where we sold in October over the near term.
Got it just depends on on what we're seeing in the market as available transaction levels Oh, Kevin If you had any.
Her thoughts on that.
No I mean, I think usually being you know that I would add is that it certainly creates a you know good.
<unk> a more favorable backdrop.
Opens the options that we have so at this point.
You know, we will kind of take a look and do some additional price discovery and and you know.
Ultimately decide if we think John you know there is additional room for improvement or is.
There's opportunities to make.
Make dispositions, we'll certainly look to do that as well, but yeah really encouraged by.
You know by that news and I think you know regardless of near term headlines. We believe our bonds are well positioned for long term incremental spread tightening just given a notable subordination unlimited bonds, why and increased investor demand not just because of this news, but because we have seen a lot of investors that are looking to put capital to work and.
And this is a sector that by and large has lags the corporate bond market you know price appreciation.
I have a backdrop, where new issuance has slowed.
Loan originations have to clone declined notably.
And although it may not be directly then it's sitting bonds that we own the continuation of the federal Reserve's term asset backed securities loan facility.
That is in place and provides.
Non mark to market terms and seem to go senior bonds in the capital structure. We think is a positive and helps create.
Create stability in the market.
It really benefits the entire capital structure.
That's it for me thank you.
And that was our last question from today's conference.
Okay, well I'd like to thank everyone for joining us and we look forward to meeting again next quarter. Thanks.
This concludes today's conference. Thank you for joining todays call.
Speakers, please stand by for transfer.
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