Q4 2020 Invesco Mortgage Capital Inc Earnings Call

Welcome to Invesco mortgage capital, Inc. 's fourth quarter 2020, Investor Conference call, all participants will be in a listen only mode and so the question and answer session at that time to ask a question.

And the star followed by the one on your telephone as a reminder, this call is being recorded.

And would like to turn the call over to Jack Bateman and Investor Relations. Mr. Bateman you may begin.

Thank you and welcome to the Invesco mortgage Capital's fourth quarter 2020 earnings call and the management team and I are delighted you've joined US and we look forward and sharing with you our prepared remarks and conducting a question and answer session and.

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 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 and involve risks uncertainties and assumptions and there can be no assurance that actual results will not materially different from our expectations.

For a 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 SEC and.

Invesco makes no obligation to update any forward looking statement.

And we May also discuss non-GAAP financial measures during today's call reconciliations.

Reconciliations of these non-GAAP financial measures may be found at the end of our earnings presentation.

To view the slide presentation today, you may access our website and invesco mortgage capital Dot Com and click on the Q4 2020 earnings presentation link under Investor Relations again, welcome and thank you for joining US today I'll now turn the call over to Johnny and below.

John.

Good morning, and welcome to <unk> fourth quarter earnings call I will give some brief comments before turning the call over to our Chief investment Officer, Brian Norris to discuss the current portfolio and more detail also John joining us on the call to continue to pay and the Q&A, our president and Kevin Collins, Our CFO Lee Phegley.

And our CFO Dave <unk>.

And I'm pleased to announce net core earnings came in at 10 cents per share.

<unk> per share for the quarter exceeding our recently increased dividend of <unk> <unk> per share.

Book value was $3 86 at quarter end, which represents an increase of 11, 2% for the quarter. The combination of the increased dividend and our book value appreciation produced an economic return of 13, 5% for the quarter and.

Improving and book value has continued since quarter ended we estimate net book value was up approximately 5% through last Friday.

Gains concentrated in January and relatively flat performance so far during February.

During the fourth quarter financial markets continued to recover as the impact of stimulus programs and optimism around the rollout and vaccinations began to take hold.

Risk assets across fixed income continued to benefit from strong investor interest and agency mortgages in particular had a strong quarter.

And as demand for current coupon agency mortgages from the Federal reserve and commercial banks outweighed elevated issuance, leading to a strong performance for the sector and <unk>.

We've largely completed our reallocation to agency MBS and in the year with 98% of our assets and agencies. We continue to take advantage of the strong demand for credit assets by further reducing our credit book by $336 million, resulting in a credit portfolio of 161 million at quarter end.

Our liquidity position remains strong as we ended December with a $745 million balance and cash and unencumbered assets.

Earlier. This month, we successfully completed a common stock offering with net proceeds of approximately $103 million that was deployed into additional agency mortgages.

And will allow us to build upon our success and restoring core earnings, while adding scale and helping to balance our capital structure.

As we look out over the next several quarters our outlook remains relatively constructive we remain positive and agency mortgages and we expect demand from the federal reserve and commercial banks to remain strong while the steeper curve and recent underperformance keeps to ROE and new investments attractive.

Funding costs should remain attractive as well as we expect the fed to keep short term interest rates low for the foreseeable future.

Despite the recent widening agency mortgage valuations remain rich and along with increased levels of prepayments presents some potential headwinds from the basis.

However, our focus and active management and security selection and purchasing specified pool collateral helps to mitigate these risks and I'll stop here and let Brian go through the portfolio.

Yeah, Thanks, John and good morning to everyone listening to the call. We added a couple of slides to the presentation and are hopeful they provide a little more background and insight on recent financial markets and general and more specifically the agency MBS sector, given the particularly attractive environment and our increased focus on the sector during the second half.

2020.

I'll begin on slide four which details the changes and the U S treasury yield curve over the past 12 months and the upper left hand chart.

Positive developments in regards to the COVID-19 vaccine and and improving economic recovery led to a bare steepening moving interest rates at the short and remained anchored while the 10 year and 30 year, both increased approximately 20 basis points during the quarter.

The upper right hand chart indicates the impact monetary policy has had on short term funding rates, which remain subdued during the quarter and continued to be attractive for borrowers and the short end of the yield curve.

Financial market volatility and the bottom left was also impacted substantially by monetary policy and continue to diminish into year and despite a modest uptick as we approached the November elections and the U S.

Lastly, and the bottom right chart, we detailed the growth in both U S Bank and Federal Reserve Holdings of agency, MBS, which had a significant impact on agency RBS valuations as we enter 2021.

Despite net issuance close to an all time record of 210 billion and the quarter. The combination of the federal reserve with the prescribed $120 billion of net purchases and commercial banks with over 200 billion of net demand during the quarter produced impressive hedged returns and the asset class, particularly and lower coupon 30.

<unk> is the primary beneficiary of the demand from both entities.

These totals resulted a net demand for the year of over 600 billion from the fed and 500 billion from banks overwhelming the historically high 500 billion of net supply.

Moving on to slide five where we provide more detail and the agency RBS market.

You can see the impact strong supply and demand technicals had a lower coupon valuation during the quarter driving treasury spread significantly tighter and the upper left hand chart.

Specified pool pay ups are shown in the upper right were modestly weaker and lower coupons as interest rates rose diminishing the need for prepayment protection, while higher coupon pay up stayed well supported and prepayments remained elevated for borrowers.

Continue to have significant incentive to refinance at current low mortgage rates.

The chart and the lower left shows the significant increase and prepayment speeds from lower coupon mortgages during the year as historically low mortgage rates and increasingly efficient refinancing drove speeds near all time highs.

And finally, the lower right hand chart shows the implied financing rate per dollar roll transactions, and 30 or two two and a half and 3% TBA is.

The implied financing rate is the reinvestment rate for which and investors indifferent between taking delivery of a mortgage pool or rolling the TBA contract forward, one month and investing the cash elsewhere.

As indicated in the chart volatility and dollar roll attracted attractiveness increased during the quarter and implied financing rates improved for higher coupon 30 year or two and a half and threes and were weaker for 30 year twos.

Dollar roll trading with implied financing rates below zero percent indicated, particularly attractive environment for investors and while lower coupon TBA or not rolling quite as well as they were late in the third and early in the fourth quarters. They still provide investors with improved funding levels for agency MBS relative to short term repo and a highly liquid securities.

<unk>.

Slide six provides detail on our agency MBS investments and.

Indicated and the upper left hand chart, and addition to the 18% allocation to agency TBA, Our agency MBS portfolio is well diversified across specified pool collateral types.

We remain focused on lower priced collateral stories mitigating our exposure to elevated pay ups and historically tight spreads and our specified pool holdings had a weighted average pay up <unk> eight points as of 12 31.

We purchased $3 1 billion of lower coupon 30 year specified pools during the quarter, while rotating out of $491 billion of underperforming pools underscoring our active management strategy within the portfolio and the superior liquidity of the asset class.

In addition, we added 800 million notional of lower coupon 30 year TBA, increasing our allocation from 14% at the end of the third quarter to 18% of dollar rolls remain an attractive and highly liquid alternative to holding specified pools and financing them via short term repo.

Our specified pool holdings paid $3 nine CPR during the quarter as a relatively newly issued pools had a weighted average loan age of five months at quarter end.

We anticipate prepayment speeds on our holdings will increase as our holding to move up the seasoning ramp, but the increase and speed should be mitigated by the recent move higher and interest rates and wider spreads and agency MBS.

We remain focused primarily in 30 or 2% and two 5% coupons as those coupons provide the most attractive combination of lower prepayment speeds and strong support via consistent Federal reserve and commercial bank demand.

While we anticipate the elevated net issuance experienced in 2020 to continue into 'twenty and 'twenty one.

We expect fed demand to absorb the net issuance, while bank demand, though and likely to match the total and 'twenty and 'twenty should provide sufficient support as bank deposits continued to outweigh loan growth.

Our remaining credit investments are detailed on slide seven with non agency MBS, representing nearly 70% of the $161 million portfolio.

John referenced on slide three we sold $336 million of credit investments during the quarter, a strong demand for our assets provided attractive exit opportunities.

Continued reduction of our credit portfolio allowed us to increase the allocation to agency MBS.

Which increased the earnings power of the company, while increasing the liquidity and reducing the credit risk within the portfolio.

Our $121 million remaining credit securities are high quality with 72% range single single, a or higher and we remain comfortable with the credit profile of our remaining holdings.

Although we anticipate limited near term price appreciation given the significant improvements experienced since the lows reached and the second quarter of 'twenty and 'twenty.

We believe these assets are attractive holdings as 100% are held on and Unlevered basis and provide attractive unlevered yields.

Lastly, slide eight details the growth of our funding and hedge book during the fourth quarter as shown in the chart on the upper left.

After paying off our secured loans at the S. H L D and August all of our remaining credit holdings are held on and Unlevered basis.

Eliminating the mark Mark to market funding risk on that portion of our book.

Repurchase agreements collateralized by agency MBS grew to $7 2 billion as of December 31.

And hedges associated with those borrowings also grew during the quarter to $6 3 billion notional of fixed to floating rate interest rate swaps.

We continue to take advantage of low interest rates further out the yield curve to lock in low funding costs via longer maturity hedges with a weighted average life of six seven years at year end.

And the potential for a steepening yield curve at the Federal reserve keeps short term rates anchored for the foreseeable future.

The modest increase in interest rates on our hedge book represents the growth of our portfolio and the rising interest rate environment experienced in the fourth quarter, while rates on our repo borrowings continue to drift lower during the quarter and into 'twenty and 'twenty, one with one month repo rates for our agency MBS holdings, averaging 21 basis points at <unk>.

And.

Our economic leverage when including TBA exposure increased from five one times debt to equity on September 30th to six six times debt to equity as of December 31st, indicating further progress towards the transition to an agency focused strategy economic.

Economic leverage since year end and modestly higher estimated at seven one times as of Friday and.

And as deployment of proceeds from our February capital raised into agency MBS investments finance via short term repo increased company leverage to our current target.

To conclude our prepared remarks, we are very pleased with the transition of the portfolio and our ability to restore a meaningful dividends for our investors during the second half of 'twenty and 'twenty. The agency MBS market continues to be well supported by the Federal Reserve purchase program as well as commercial bank demand and robust demand for our credit assets has.

Provided us with opportunities to reallocate equity into agency MBS.

While the prepayment environment and agency RBS remains challenging.

We believe our careful selection of prepayment protection active management and higher mortgage rates will mitigate the potential for faster prepayment speeds.

And their negative impact on yields.

In addition, while agency MBS spreads appear tight.

Recent underperformance and bear Steepening of the yield curve will benefit reinvestment opportunities.

Lastly, monetary policy remains very supportive and we expect that to continue throughout 2021 as the federal reserve communicate the desire to maintain and accommodative stance over the medium term.

Thank you for your continued support from Invesco mortgage capital and now we will open the line for Q&A.

Thank you at this time, we will now begin the question and answer session. If you would like to ask a question. Please press star one please on mute your phone and record your first and last name clearly what prompted your name is required to introduce your question to withdraw. Your question you May Press Star two once again at this time, if you would like to ask a question.

Please press star one.

And our first question is from Doug Harter with Credit Suisse. Your line is open.

Thanks.

And and good morning, hoping you could talk a little bit about the capital deployment.

You know kind of what are what types of returns and spreads did you see kind of when you were putting.

Putting that money to work.

And then also you.

You said that Leverages now seven times and I guess, if you could just put that in context of you know.

Yeah.

Given if spreads were to widen a little bit more do you see if you would have room to kind of take that up a little bit or how youre thinking about the range of weapons.

Yeah, Hey, Doug, it's Bryan and I can talk a little bit about.

The deployment of proceeds.

We basically reinvested those proceeds into lower coupon agency mortgages, so similar to to kind of how we built the portfolio over the last couple of quarters a row.

Those.

And we're talking to early February Roe's on specified pools were right around 10.

Per cent so call it maybe 9% to 11 range, whereas we also added some some agency TBA as well and and at the time agency TBA was kind of mid to high teens Roe.

So you know since then.

You know over the last couple of weeks, we've seen the agency mortgages underperform and we've seen our ROE is improve a decent amount maybe call. It 200 basis points, so kind of bumped that up to 11% to 13% for specified pools.

And so you know with leverage right around seven and and kind of where we've intended it to be but it does give us room you know if.

And if this kind of continues it and are always can become more attractive. We can we can add to that certainly.

Great.

Yeah, and I guess, if you could just talk you mentioned that this capital raise was you know kind of used to rebuild you know what kind of help continue to rebuild kind of core earnings.

If spreads continue to kind of.

Get more and more attractive what would your appetite be for for raising additional capital.

Yeah, Doug This is John Yeah, I mean, you know.

And I think we're going to raise capital.

And we see opportunities for it to be accretive.

And this one was.

Accretive to ROE, certainly and and also I mean, I think helping to rebalance the capital structure to a better balance between our common and preferred is another goal. So I think you know I mean, if the opportunity presents.

And we'll certainly look at that and especially given where we're always are certainly.

If we were to put our money to work now or in the near future and we think it would be very accretive to our two core so yeah I mean.

We definitely are.

Look at that.

Great. Thank you John.

Our next question is from Trevor Cranston with JMP Securities. Your line is open.

Alright, thanks, good morning.

John.

You guys mentioned, the recent underperformance of mortgages and a couple of times in the prepared comments.

And then I think I heard you say draw and the or book value and February was about flat and I was wondering if you could.

Just help us kind of square those two factor.

Factors and if you know comments on and if there was any changes to the portfolio or the hedge book and that helped our book value would stay flat despite underperformance from embryos.

Yes.

Yeah. This is John and Brian you and I got.

Yeah, I can take that a little bit okay. Yeah. So yeah.

I mean, we had released and estimated book value range at the end of January which was kind of where we were as of Friday. So we saw a decent amount of you know.

Gains and the early part of February.

But over the last call. It 10 days or 12 days or so mortgages underperform. So that kind of came back down to where we were flat through Friday.

Okay I got you that's helpful.

More generally.

You know rates have obviously been trending a little bit higher can you guys talk about how you guys think about extension risk within the portfolio and you know how and how you guys are approaching.

Managing that conceptually ex.

Yeah, certainly as rates rise and given the.

Makeup of our portfolio you know there is going to be some extension and our bonds and we've we've been hedging pretty long.

And since since we started this kind of rebuild and the and the third quarter, so no longer dated swaps.

And even out to 30 years to help protect us from from that.

Okay got it and just to clarify and that on the deployment of the proceeds from the offering.

Was any of that capital deployed into Tvs or was that a.

Primarily deployed into a spec pools.

Yeah. Some of it was and the TBA is just to kind of keep our allocation, we'd like given where how attractive ppas are weighted kind of like the allocation you know and that upper teens area. So you know with the new capital, we pretty much invested it.

To keep it there.

Okay got it I appreciate the call and thank you guys.

Yeah.

And so some of them showing no further questions.

Sorry did you say no more questions.

Oh, yes, I'm showing no questions no further questions at this time.

Okay, well, if theres no more questions. Thanks, everybody for listening and we will see you next quarter. Thanks.

Thank you for participating in today's conference all lines may disconnect at this time.