Q2 2021 Invesco Mortgage Capital Inc Earnings Call

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Welcome to the Invesco mortgage capital second quarter 2021, Investor Conference call. All participants are in a listen only mode until the question and answer session at that time to ask a question. Please press star 1 on your telephone keypad as a reminder, this call is being recorded.

Now I would like to turn the call over to Jack Bateman and industrial relations. Mr. Bateman and you may begin your call.

Thank you and welcome to the Invesco mortgage capital second quarter 2021 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. The.

Before turning the call over to our CEO, John Anzalone I wanted to provide a reminder, the 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 the NV.

All of risks uncertainties and assumptions and there can be no assurance that actual results will not differ materially 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.

Invesco makes no obligation to update any forward looking statement. 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. The.

And the slide presentation today, you may access our website and invesco mortgage capital Dot Com and click on the Q2.2021 earnings presentation link under Investor Relations and again welcome and thank you for joining us today.

Now I'll turn the call over to John Anzalone John.

Good morning, and welcome to Invesco mortgage capital second quarter earnings call.

A brief comments before turning the call over to our Chief investment Officer, Brian Norris to discuss the current portfolio of more detail also joining us on the call to participate in the Q&A, our president and Kevin Collins, Our CFO, Lee Phegley, and our CFO Dave while.

Burns and and increased likelihood of the federal reserve timeline for reducing asset purchases would be accelerated more than offset steady fed demand of <unk>.

The value performance reflected this under performance and in the quarter down 12% of $3 and 21.

Looking ahead, many of the headwinds of the mortgage basis face during the second quarter remain intact prepayments speeds moderated during the quarter, but remained elevated and the lower interest rate environment of quarter and should keep prepayments near historic highs over the coming months.

Increases and inflation across many parts of the economy keep the uncertainty around the feds plan to taper, it's asset purchases at of heightened level. While these factors remain challenging we expected. The recent widening of spreads along with a favorable funding environment through both traditional repo and via the dollar rolls to continue to help support the earnings powerful.

Portfolio over the coming quarters, I'll stop here and let Brian go through the portfolio.

Alright, Thanks, John and good morning to everyone on the call and I'll begin on slide 4 and the upper left hand chart, which details of the changes and the U S treasury yield curve since you're and as indicated by the dark Blue line and the second quarter ended with a partial reversal of of the first quarter of sharp horizon longterm yields resulting in of flattening of the yield curve market optimism Rees.

Tilting largely from the successful rollout of COVID-19, vaccinations and reopening of the service sector became a bit more muted after an uptick in cases due to the more contagious Delta variant.

In addition, the federal reserve successfully damp and the market's initial concern regarding the notable increase and year over year inflation by effectively communicating their projections for a softening of inflation pressures as the reopening of the economy moves forward.

As noted these adjustments resulted in a bowl of flattening of the yield curve of short term interest rates with 3 years or less of maturity increased by of modest 5 to 10 basis points, while longer term 10 to 30 year rates declined approximately 30 basis points. This move was exacerbated by short covering and the interest rate swap market as positions designed to <unk>.

If it from a move higher and rates were forced to unwind, resulting and tighter swap spreads during the quarter as indicated by the chart and the lower left hand section of slide 4.

Both the flatter yield curve and tighter swap spreads had negative ramifications for the agency rmb's market. Despite the continuation of attractive funding rates as indicated and the upper right hand chart and strong demand from both the federal reserve and commercial banks indicated and lower right hand chart.

Moving on to slide 5 where we provide more detail on the agency rmb's market and the upper left hand chart. We show year to date generic lower coupon agency Rmbp's performance versus swap hedges, highlighting the second quarter and Gray as you can see agency mortgages underperformed sharply and May and June offsetting modest gains of.

On April as the flatter yield curve lead to reduced demand from commercial banks, while the decrease and the 30 year mortgage rates increased prepayment concerns.

Agency MBS investors, given the sharp economic recovery and hawkish commentary from Nonvoting Fom's. The members began to price in the potential for and earlier than expected tapering of asset purchases, including the possibility of of faster pace or earlier start and agency RMB us relative to use the treasury purchases and of.

Addition, net supply remained elevated totaling $290 billion during the quarter, which was double the annual average during the 10 year period from 2010% of 2019.

The 470 billion of net supply during the first half of 2021 nearly matches the $508 billion of debt supply for the full year 2020, and although we expect the pace of net issuance to decline during the second half of the year 2021 annual market projections have increased the over 700 billion far surpassing.

2020 to record total special.

Specified pool payouts as shown in the upper right relatively unchanged after significant underperforming and the first quarter as prepayment speed showed on modest decline from elevated levels given the typical lag from higher mortgage rates and February and March.

We expect the recent decline and mortgage rates combined with the strength of the housing market to keep prepayments speeds elevated and the coming months.

Lastly, the lower right hand chart details of the implied financing rate per dollar rolled transactions, and 30 or 2% to 5% and 3 per cent tva's the.

The implied financing right as the reinvestment rate for which and investor is indifferent between taking delivery of of mortgage pool or rolling the TBA contract forward, 1 month as indicated and the chart and plied financing rates improved during the quarter as the yield curve flattened increasing the attractiveness of the dollar roll market for investors and lower coupons.

Slide 6 provides detailed on our agency rmb's investments and our activity during the second quarter elevated valuations early in the quarter combined with increasing headwinds and the sector prompted us to reduce exposure to agency RMB us through a combination of asset sales and prepayments.

As indicated and the upper left hand chart, our exposures remain focused and lower coupon 30, or 2% and 2 and 5 per cent specified pools and TBA. However, we moved modestly higher and the coupon stock is cheaper evaluations and 33%.

Provided and and attractive entry point.

During the quarter, we purchased 1.6 billion of 30 year 3 per cent specified pools funded by sales of 30, or 2 and 5 per cent pools as higher rates and wider spreads improved projected returns and higher coupons.

During the quarter, we continued to rotate and the lower pay up specified pools as we remain focused on mitigating our exposure to elevated pay ups as indicated and the chart at the bottom of slide 6 we sold higher pay up stories, such as loan balance and Geo.

While increasing allocations to lower pay up new production, hi, LTV and low FICO stories.

Are specified pool holdings had a weighted average pay us of 0.6 points as of 630 of modest increase from a half of point as of 331 reflective of our move and a higher coupons the.

The weighted average yield on our agency Rmb's holdings improved 16 basis points to 2.04% as of quarter and.

While prepayments on our holdings remain low at 6.4 CPR for the quarter.

We believe the strength of the dollar or market and wider spreads present attractive entry points with roe's on lower coupon dollar rolls and the mid teens and specify pools, ranging from 9% to 11%.

Our remaining credit and investments are detailed on slide 7 with non agency MBS, representing nearly 60% of the $108 million portfolio and.

The decline during the quarter is reflective of bond maturities and Paydowns with no asset sales during the quarter.

<unk> 74 million of remaining credit Securities are high quality with 90 per cent rated single layer of higher and we remain comfortable with the credit profile of our remaining holdings, Although we anticipate limited near term price appreciation. We believe these assets are attractive holdings as 100% are held on and Unlevered basis and provide attractive.

[noise] unlevered yields.

Lastly, slide 8 details are funding book at quarter and as shown on the chart on the upper left repurchase agreements collateralized. The agency RMB US declined to 7.9 billion as of June 30th given the modest decline and our holdings.

Hedges associated with those borrowings decreased to of net 5.3 billion notion of pay fix receive floating interest rate swaps as further confidence and the duration of the federal reserves of accommodative monetary policy stance provided an opportunity to reduce our hedge ratio from 77% to 67% during the quarter.

And the weighted average interest rate on our hedge book remained unchanged at 41, 0.41%, while further improvements and agency rmb's borrowing costs led to a decline and are weighted average funding rate to 0.1% as of June 30th in order to of hedge additional exposures further out of the yield curve, we held 1.

3 billion notional of forward, starting interest rate swaps with starting dates and 2023 concurrent with our expectations for potential adjustments and monetary policy or economic leverage when including TBA exposure ticked modestly higher during the quarter to 6.8 times debt to equity as we remain conservatively positioned given the.

Rich valuations and our target assets.

To conclude our prepared remarks, the second quarter with the challenging on for agency RMB US investors, representing 1 of the top 5 worst quarters for relative performance since the European debt crisis, and the fall of 2011 and combined with the underperformance and the first quarter 1 of the worst 6 month returned since 2008, Although agency rmb's valuations remain at relative.

The high levels on the historical basis, we believe elevated valuations and other high quality fixed income of alternatives should keep any potential for further agency RMB us underperforms relatively muted compared to the first half of the year positively net supply should Wayne as we move into the second half of the year and strong.

The bank and Federal reserve demand should continue to support the market with current expectations of early 2022 from the beginning of of taper and asset purchases.

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

We will now be and our final question and answer session. If you would like to ask your question and I phone. Please price the star 1 on your telephone keypad only be caught your first and last name.

And the first question is coming from the corner of credit Suisse. Your line itself.

And.

More and everyone. This is Josh on for dogs I appreciate the color on on muted spread widening and in the back half of the year expected just wanted to get your thoughts on how much more spread widening you think.

We could potentially see ahead of the fed taper versus how much may already be price day. Thanks.

Yeah, Josh Hey, this is Brian.

We've seen about 25 basis points of widening from the types of that we saw in mid may.

And.

The expectation is that we will probably see another 10 to 15 basis points of widening.

That's not necessarily going to occur before tapering begins the kind of throughout the process. So we think that the.

Any further widening will be much more gradual than what we saw during the second quarter so out of.

I think ultimately about 40 basis points wide wider from the types that we saw and may as of reasonable assumption over the next call.

Call It a couple of quarters.

Great makes sense. Thanks for that Brian and then curious if you could give us an update on how book value of his trended quarter to day. Thank you.

The quarter of the date were roughly down about 2%.

Great. Thanks, so much for the for the comments.

Yep.

And once again and if you do have the question. Please price star 1 on on your telephone keypad and the next question is coming from the charter Cranston JMP Securities.

Hey, Thanks, good morning.

Alright, and you could talk about your outlook for prepaid speeds with rates continuing to fall and July.

And the removal of the adverse market reply charge.

And and specifically how response of you think the coupons you guys zone.

Would be to mortgage rates.

Dropping back below meaningful of 3 per cent.

The a drivers of Brian and I think generically speaking for the market. We expect prepayment speeds. The remain fairly elevated as you noted I think the 30 of mortgage rate is around 280 now so.

Certainly it's dropped 40 or 50 basis points from from March levels.

So we think that.

Prepay speeds, particularly and 2 and a half coupons and hire are going to remain elevated for our for our bonds.

We continue to see pretty low levels of.

Prepayments and that's partially due to the the.

The well the lack of seasoning of our holdings. So we do expect that to drift a little bit higher and we don't expect it to be too dramatic we still have a fair amount of our holdings and 2% pools, which we expect to continue to pay.

Relatively slow at these levels, if we were to move even lower than the neck come into question, but we expect our 2 and a half and 3% pools to to drift a little bit higher from here, but.

<unk> to be relatively stable.

Got it okay. That's helpful.

And then with respect to the interest rate environment and it seems like agencies spreads of been more stable and the third quarter as rates of come down.

Just curious to get your thoughts on how you think mbo's with generally perform.

Of the 10 year does continue to move lower and the old per buttons and Conversely, how you think the performance of that.

A couple of weeks ago.

Yeah the.

The widening that we've seen since quarter and has been a little bit more gradual as we noted realm.

Relative to kind of the second half of the second quarter.

Mortgages.

Should continue to underperform and too bold flatness, so as as longer.

Rates continue to rally.

But Conversely, I think mortgages could do okay, and I think banks have a decent amount of cash to put the work. So they're just waiting for kind of of modest.

Backup and rates and mortgage is should should handle that pretty well.

Okay got appreciate the kind of thinking.

The next question and it's coming from teeth and Stuart Jones training. Your line is open.

Hi, good morning, and thanks for taking the questions quick follow up on the I guess on on the FHFA changes how are you thinking about what scene of Thompson and may or may not too and positioning the portfolio for any potential impact.

Yes, we we do think that the changes of the FHFA should be more borrower friendly which means that.

It should be easier for higher coupon borrowers and lower credit borrowers to refinance so that means that debt higher coupons should continue to see elevated prepayments, particularly at the at these right levels. So.

We've avoided anything higher than 3 per cent coupon and we think that those coupons will continue to struggle and this environment.

Okay do you have a house view on how the policy evolves from this point going forward.

And as far as conservatorship.

And I think that.

They are clearly going to approach that more slowly than the previous administration. So I think we have a fair amount of time.

But again I think the new policies will be more geared towards being borrower friendly.

And and increasing access to these lower mortgage rates.

Okay.

<unk>. Thanks.

Yep.

At this time, we have no further questions and Q.

Okay, well I think the thank everybody for joining us on the call and we look forward to talking to you talking to you next quarter. Thanks.

Okay. So today's conference all parties may disconnect at this time.