Q3 2021 Invesco Mortgage Capital Inc Earnings Call

This call is being recorded now I would like to turn the call over to Jack Bateman and Investor Relations. Mr. Bateman, you may begin the call.

Thank you and welcome to the Invesco mortgage capital third quarter 2021 earnings call.

Management team and I are delighted you've 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 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.

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 risks described in our most recent annual report on Form 10-K, and subsequent filings with the SEC.

Wesco 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.

If you the slide presentation today, you may access our website at Invesco mortgage capital Dot Com and click on the Q3 2021 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 Invesco mortgage capital third 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 in more detail.

Also joining us on the call to participate in the Q&A, Our president Kevin Collins, our CFO Lee Phegley, our CFO, Dave Lyle.

I am pleased to announce earnings available for distribution for the third quarter came in at <unk> 10 per share.

Book value ended the quarter at $3 25 per share, which represents an increase of one 2%.

And book value combined with our <unk> and dividend produced an economic return of 4% for the quarter.

The portfolio remains predominantly agency focus with substantially all of our entire $8 $8 billion portfolio, plus $1 5 billion notional and TVA.

<unk> and agency mortgages, our liquidity position remains strong as we held $788 million of unrestricted cash and unencumbered investments at quarter end.

After underperforming sharply during the second quarter agency mortgage performance stabilized during the quarter as positive performance from higher coupons generally offset underperformance from the bottom of the coupon stack.

Higher coupons benefited from slowing speeds as signs of prepayments burnout spurred investor demand lower coupon struggled is the market ready for the onset of asset purchase tapering by the federal reserve.

Looking ahead, we believe that earnings available for distribution will continue to be supported by attractive dollar rolls and slow speed than our specified pool collateral as well as by an attractive reinvestment environment characterized by wider spreads and continued strong funding markets.

While the near term technical picture for mortgage remains supportive of evaluations. We are cautious over the next several quarters as the decrease in purchases by the federal reserve and the likely increase in seasonally driven supply remains headwinds.

I'll stop here and let Brian go through the portfolio in more detail.

Yes.

Thanks, John and good morning to everyone listening to the call I'll begin on slide four in the upper left hand chart, which details the changes in the U S treasury yield curve since year end.

As indicated by the light Blue line, the third quarter ended with interest rates largely unchanged with a modest flattening twist at the 10 year portion of the curve, resulting in the difference between the yield on the 30 year and five year U S treasuries falling by 12 basis points.

The quarter began amidst rising concerns regarding the economic impact of the COVID-19 Delta various resulting in a 30 basis point decline in the 10 year U S. Treasury note and the first five weeks of the quarter.

Improving economic data increased inflation expectations and.

Vacations of our peak in Covid cases, and clear signals from the federal reserve on the timeline for tapering asset purchases at the September <unk> meeting led to a reversal in rates during the last couple of weeks of the quarter with a 10 year largely unchanged at $1, 49% at quarter end.

Conversely swap spreads reversed the tightening in the first half of the year and widened back to year end levels as displayed in the lower left hand chart, resulting in higher swap rates across the curve during the quarter and benefiting those with a higher percentage of their hedges and interest rate swaps.

Despite short term funding rates remaining attractive the decline in interest rates in the first half of the quarter and the increase in interest rate volatility led to a reduction in commercial bank demand for agency mortgages with monthly purchases of approximately 28 billion per month compared to the 46 billion.

Months average in the first half of the year.

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

In the upper left hand chart, we show year to date agency mortgage performance versus swap hedges and generic 30 year, two two and a half and 3% coupons, highlighting the third quarter and Greg.

You can see lower coupon 30 year, two and two 5% coupons modestly underperformed during the quarter, while 30 year coupons, 3% and higher outperformed.

Lower coupons underperformed largely due to the increased expectations for asset purchase tapering in the fourth quarter.

As well as the previously mentioned decline in commercial bank demand and the increase in interest rate volatility.

Higher coupons benefited from the perceived peak in prepayment speeds.

Indications of modest prepayment burn out for higher coupon borrowers continued.

Specified pool pay ups as indicated in the chart on the top right.

Improved as interest rates fell during July and remained elevated relative to the second quarter through the end of September.

We have seen a reversal of this move so far in the fourth quarter as the recent modest increase in mortgage rates and decline in refinancing activity has dampened demand.

For prepayment protection.

Implied financing in the TBA market shown in the lower right hand chart remains attractive in lower coupons with financing rates drifting modestly lower while still volatile higher up the coupon stack as indicated by the purple line, representing the 30 year, 3% TBA.

We believe supply and demand technicals should remain supportive of the dollar roll market in the near term despite reduced demand from the federal reserve and we're likely to maintain a significant allocation and ppas as a result.

Slide six provides detail on our agency MBS investments and our activity during the third quarter.

While our overall allocation to the sector was largely unchanged, we modestly reduced exposure to lower coupons through paydowns and invested the proceeds and 30 year, three 5% specified pools, increasing our coupon diversification and higher coupon allocation by approximately $300 million.

We continued to actively manage our specified pool holdings rotating $2 1 billion into more attractive alternatives within the sector, while mitigating our exposure to elevated pay ups.

Our specified pool holdings had a weighted average pay up <unk> nine points as of September 30.

An increase from <unk> six points as of June 30th Despite our rotation away from higher pay up loan balance stories into new production.

Reflective of the market's increased demand for specified pools during the quarter.

As noted on the previous slide we have seen a reduction in demand for prepayment protection. So far in the fourth quarter as our weighted average pay up has declined back to the June 30th average of <unk> six points.

The weighted average yield on our agency MBS holdings improved seven basis points to two 1% as of quarter end.

While prepayments on our holdings remained low at seven 3% CPR for the quarter.

We believe the strength of the dollar roll market and wider spreads represent attractive investment opportunities with rovs on lower coupon dollar rolls in the mid teens and 9% to 11% on specified pools.

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

Our allocation to credit remained stable during the quarter with no asset sales and limited price movements overall.

Our $73 million of remaining credit securities are high quality with 90% rated single a or 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 at 100% are held on an unlevered basis.

And provide attractive unlevered yields.

Lastly.

Eight details our funding book at quarter end as shown in the chart on the upper left.

Repurchase agreements collateralized by agency MBS remain unchanged at $7 9 billion as of September 30th.

Given the modest decline in our holdings in hedges associated with those borrowings also remained unchanged at $5 3 billion notional of pay fixed receive floating interest rate swaps.

The weighted average interest rate on our hedge book remained unchanged at 41 basis points, while modest extension and the maturities of our repurchase agreements led to a two basis point increase in the average funding rate to 12.

12 basis points.

In order to hedge additional exposures further out the yield curve, we continue to hold $1 3 billion notional of forward starting interest rate swaps with starting dates in 2023 or.

Our economic leverage, including TBA exposure tick modestly lower during the quarter to six five times debt to equity as we remain conservatively positioned.

To conclude our prepared remarks, we are very pleased with the performance of the company in the third quarter and we believe our conservative leverage and liquidity position provides an opportunity to capitalize on attractive investment options as they become available in the future.

Spread widening of nearly 30 basis points since may supports an attractive investment environment in the agency MBS sector with Roes ranging from high single digit on specified pools to mid teens on TBA and.

And we believe valuations should be relatively well supported in the near term. Despite the reduction in fed purchases as commercial bank demand route.

Demand remains robust and supply declines thank.

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

Thank you very much we will now begin the question and answer session. If you would like to ask a question. Please press star one please.

Please on mute your phone and record your name clearly when prompted your name is required to introduce your question and to withdraw your request press star two.

One moment please for the first question.

Our first question now is from Trevor Cranston with JMP Securities. Sir Your line is open.

Hey, Thanks, good morning.

I wanted to follow up on your comments about.

Specified pool pay ups and the fact that they've come down some in the fourth quarter.

I was.

How you're viewing.

<unk> higher coupons specified pools overall.

With the amount that come down in the fourth quarter.

Do you think those are likely to continue to come down as.

Speeds show more and more burn out or sort of how are you thinking about the risk of payoff levels here. Thanks.

Hey, Trevor its Brian yes.

<unk>.

We remain pretty cautious on higher coupon specified pools in particular.

The TBA market.

And in higher coupons is also.

Not overly attractive as well and we do think that there will be pressure on those pay ups. So we did move.

Into 30 year threes during the second quarter, and a little bit into three and a halves.

But we remain in relatively generic collateral and those coupons as we do think that.

Pay ups could continue to feel some pressure as we move forward here.

Okay got it.

And then on the Unlevered side of things I was curious because COVID-19 is generally talk about.

How much how much of a widening you'd like to see in the market before you'd be looking to take the leverage up meaningfully from where it is today.

Yeah, we think that.

Spreads.

Yeah.

Spreads are relatively tight I mean, they have widened a fair amount like I said since since may.

But we think that they could remain that way for.

Four.

Other quarter or so.

Before supply pressures in the middle of 'twenty, two as well as the fed reductions.

You know kind of kind of have a bigger impact.

On the on spread outlook so.

Over the next year, we would anticipate.

Spreads returning near closer to kind of 2019 levels.

Which could be another 20 basis points or so.

So we'll look for.

Yeah.

A portion of that widening before we start adding to our current leverage which is pretty conservative.

I'd say, it's kind of at the low end of our target range at this point.

So we could start adding as as we see spread widening occur.

Okay makes sense I appreciate the comments thank you.

Thank you very much to ask a question at this time. Please press Star then one one moment please.

As I have no further requests and now we'd like to turn it back to management for any closing remarks.

Okay well.

Thanks, everybody for joining the call and we look forward to revisiting everyone.

Next quarter. Thank you.

Conference is now concluded again, thank you for your participation. Please go ahead and disconnect.