Q4 2021 Invesco Mortgage Capital Inc Earnings Call

Welcome to Invesco mortgage capital, Inc. Fourth quarter 2021, Investor Conference call, all participants will be in a listen only mode until the question and answer session at that time to ask a question press the star followed by the one on your telephone.

This call is being recorded now I will turn the call over to Jack Bateman and Investor Relations. Mr. <unk> you may begin the call.

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

Management team and I heard the why did 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 a reminder that statements made in this conference call and the related presentation may include forward looking statements, which reflect management's expectation about future events and our overall plans and performance.

These forward looking statements are made as of today and are not guarantees.

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.

Also discuss non-GAAP financial measures during todays call.

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 at Invesco mortgage capital Dot Com and click on the Q4 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's 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 in more detail also joining us on the call to beach to participate in the Q&A, Our president Kevin Collins, our CFO Lee Phegley, our CFO David <unk>.

I'll.

The fourth quarter was characterized by challenging market conditions I, just federal reserve responded to surging inflation by signaling a significantly more hawkish policy staffs.

The yield curve flattened during the quarter as the market began to price in more aggressive rate increases by the excellent. Thank you.

We entered 2022 yield curve has flattened further in interest rates moved higher as the market responded to even higher inflation print pricing and not only more rate increases the capacity reduction reductions in the first two and a half a trillion dollars agency mortgage holdings.

Given the increased rate interest rate volatility flatter curve and hawkish pivot by the fed mortgages significantly underperformed during the fourth quarter, leading to a decline in our book value of 10, 5% during the quarter. This decrease combined with our dividend gave us an economic return for the fourth quarter of negative seven.

7%.

Our book value declined an additional 9% during January as a spread widening in agency mortgage accelerated.

Hey at some specified pool collateral collapsed amid much higher mortgage rates.

Our liquidity position remains strong as we held 871 million of restricted cash and unencumbered investments at year end.

Earnings available for distribution should continue to be supported by relatively attractive dollar rolls as well as by an attractive reinvestment environment characterized by wider spreads and continued strong funding markets were.

Remain cautious on agency mortgage valuations as deal ultimate pace of fed portfolio dispositions remains highly uncertain.

Stop here and let Brian go through the portfolio.

Thanks, John and good morning to everyone listening to the call I'll begin on slide four with the upper left hand chart, where the significant shift towards a more hawkish Federal reserve has been reflected in the U S. Treasury yield curve as indicated by the dark Blue line. The fourth quarter ended with the 10 year U S treasury yield largely unchanged for the second consecutive quarter.

<unk> rising only two basis points to a $1 five 1%, while the rest of the yield curve continued to flattening twist that started during the second quarter.

Two year U S treasury yield climbed to 46 basis points to 0.73% during the fourth quarter.

While the 30 year U S treasury yields fell 14 basis points to 2.5%.

The yield curve is now 150 basis points flatter between the two year and 30 year maturities from March of 2021 to this past Friday.

The flattening yield curve has negatively impacted our book value as our longer dated hedges have underperformed those in the front end of the curve.

The upper right hand chart displays how the short term funding markets began to price in tighter monetary policy by the end of January with three months sofa, reflecting a 25 basis point hike in March while the lower left hand chart details the changes in the market implied fed funds futures contracts, which were calling for approximately <unk> <unk>.

<unk> interest rate hikes in 2022.

At the end of January a sharp increase relative to the one rate hike in 2022 that was expected.

At the end of September .

Since the end of January this has now climbed to seven interest rate hikes. This year with a greater than 50% chance of a 50 basis point hike in March.

While the federal reserve will still net adding agency MBS of 110 billion during the fourth quarter. Despite the onset of take rate <unk>.

Commercial bank purchases continued to slow with current estimates in the range of 60 to 70 billion for the quarter.

Net purchases from the Federal reserve will cease in March leading commercial banks and money managers at the most likely dominant sources of demand for agency MBS This year.

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

In the upper left hand chart, we show agency RBS performance versus swap hedges since the beginning of 2021 and generic 30 year, two two and a half and 3% coupons highlighted in the fourth quarter and Greg all.

All three coupons underperformed during the quarter, particularly in November at the Federal Reserve signaled a more aggressive timeline for interest rate hikes and tapering of asset purchases.

This underperformance has continued in the first six weeks of 2022.

With the minutes of the December epilepsy meeting, indicating the increased likelihood of reductions in the federal reserve balance sheet in the second half of this year. The January <unk> meeting reinforcing those plans and the minutes from the January meeting released earlier this week, indicating some discussion by the federal reserve on outright asset sales.

From the balance sheet.

While the base case expectation is for the federal reserve to reduce the agency MBS portion of the balance sheet via Paydowns subject to monthly caps.

<unk> market concerns in regards to potential outright asset sales by the fed have led to continued underperformance in February .

Positively the seasonal slowdown in housing activity and modestly higher mortgage rates have slowed prepayment speeds as shown in the bottom left hand chart supporting the earnings power of the company.

However, the combination of slower speeds higher interest rates and a persistently attractive dollar role market from lower coupon TBA resulted in a notable decline in pay ups on specified pool collateral indicated in the top right chart.

These trends have also continued into 2022, given the significant increase in mortgage rates this year.

In the bottom right chart implied financing rates on lower coupon TBA remained negative in the fourth quarter with 32% and two 5% coupons trending towards positive financing rates over the past few weeks.

Attractive implied financing rates and production coupons should persist in the coming months, although we expect some deterioration as the supply and demand technicals worsen in the second quarter.

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

We reduced our allocation through outright sales of lower coupon securities and Paydowns on the total portfolio given continued challenges in the sector. While the earnings capacity of the company remained robust through attractive funding markets and relatively slow prepayment speeds.

In addition, we continued to actively manage our overall allocation moving up in coupon from 32% to 30, or two and a half and 3% specified pools and rotating a portion of our holdings into more attractive collateral stories.

Spite moving up in coupon the weighted average pay up on our specified pool holdings fell approximately a quarter point to 0.7 points as demand from lower coupon specified pools declined given slowing prepayment speeds and modestly higher mortgage rates.

As noted on the previous slide this trend has continued into 2022 with our weighted average pay up declining approximately another quarter point from year end.

Our allocation to TBA securities climbed from 15% to 18% at year end as a modest increase to higher coupon TBA combined with the reduction in the overall portfolio.

The weighted average yield on our agency MBS holdings declined four basis points to two 7% as of quarter end as prepayments on our holdings increased modestly to seven seven CPR for the quarter.

Prepayment speeds on our holdings should remain low as the mortgage rate clients from a low 3% range to 4%.

Although we have seen a decline in the attractiveness of the dollar roll market and lower coupon TBA opportunity is higher than the coupon stack continue to support the earnings capacity of the company and we believe wider spread in specified pools represent attractive investment opportunities.

Current ROE on production coupon dollar rolls are in the mid teens, while specified pool ROE have climbed into the low double digits. We.

We believe this trend will continue in the coming months as dollar roll and specified pool ROE converge given the reduction in fed purchases of TBA collateral and wider spreads 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 $72 million of remaining credit securities are high quality with 90% rated single a or higher and we bring that we remain.

Are you comfortable with the credit profile of our remaining holdings.

Although we anticipate limited near term price appreciation. We believe these assets continue to be attractive holdings at 100% are held on an unlevered basis and provide attractive unlevered yields.

Lastly, slide eight details our funding book at quarter end as shown in the chart on the upper left.

Repurchase agreements collateralized by agency MBS declined to 7 billion as of December 31.

Given the reduction in our specified pool holdings and hedges associated with those borrowings also declined to $4 6 billion net notional pay fixed received floating interest rate swaps.

The weighted average interest rate on our hedge book fell to 30 basis points as.

As we fully transitioned our interest rate swaps from LIBOR to sofa, which resulted in a modest reduction in both fixed and floating rates given the elimination of the LIBOR credit spreads.

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.

Our weighted average repo cost increased two basis points to 0.14% and have climbed modestly higher to a weighted average of approximately 0.1 hundred 7% currently as the funding markets begin to price said tighter monetary policy in the coming months.

Our economic leverage when including TBA exposure declined during the quarter to six two times debt to equity and we continue to maintain leverage in that context year to date.

To conclude our prepared remarks significant challenges in the agency MBS market persist and we are remaining conservatively positioned as pressure from widening spreads and lower pay ups on our specified pool collateral has led to the decline in book value year to date.

The Federal Reserve is set to conclude net purchases of agency MBS in March and we expect run off of the balance sheet to begin in the middle of this year.

The worsening supply and demand technicals are likely to pressure spreads wider in the near term as we believe fair value given our balance sheet runoff scenario is approximately 15 basis points wider from current levels.

While outright sales from the fed balance sheet will likely remain an option while inflation remains elevated we do not believe this to be a 2020 to that and would expect outright sales to remain a low probability that it's inflation moderates as expected in the second half of this year.

In the meantime, we will remain conservatively positioned and ready to take advantage of more attractive entry points in the future.

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

Thank you if you would like to ask a question. Please press star one on your phone to withdraw your question Press Star two once again to ask a question. Please press star one.

Our first question comes from Doug Harter with Credit Suisse. Your line is open.

Thanks, John I believe you mentioned that.

The January book value.

Just kind of continued pressure in February just wondering if <unk> give us.

I paid on how February has performed.

Sorry, I was on mute there.

Brian you want to take that one on Germany.

Yeah, I mean, yeah February so far we've seen continued pressure as we mentioned in.

Book value through.

A few days ago was down another 5% to 6%.

So okay. So another five to six in February on top of it but I think you said nine for January .

Correct.

Got it and then just just to clarify when you were talking about kind of how you saw fair value.

You can see we're saying we could see another 10 15 ish basis points of widening just to be clear that would be from.

Today's levels.

Yes, that's correct yes.

Yeah.

Yeah.

Treasury OAS has about 25 wider year to date.

And about 50 basis points wide of the types that we saw last year.

So we expect another 15, if the balance sheet has allowed to just run off.

Got it and I guess, just help us understand kind of what you.

What it is about that level or Wow.

At that level that kind of why you think that's fair valued not versus kind of more or less just to help us frame that.

It puts us back into the context kind of pre pandemic levels and maybe just a touch wider just given the elevated volatility relative to that time period.

Got it I appreciate the answers thank you.

Yep.

Once again to ask a question. Please press star one our next question comes from Trevor Cranston with JMP Securities. Your line is open.

Alright, thanks, good morning.

Follow up on the question about the you know the increased volatility in the first quarter so far.

And the book value performance.

I think I heard you say in the prepared remarks, the leverage had been held flat.

From the end of the year. So first question is did I hear that correctly.

And.

Secondly.

Have there been any significant changes within the portfolio.

We should note.

Given how much rates will grow spreads widen so far in the quarter.

Yet the charter Hey, it's Brian good morning.

Yes leverage right now.

Is right around the $6 two level than it was at year end, you know it moves around a little bit.

Throw out throughout the year, but but right now it's about that same level.

We have continued to kind of move a little bit.

Up in coupon since year end so.

We've reduced our continued to reduce the size of the portfolio.

To help manage leverage and so most of those reductions have been in lower coupons.

Okay Gotcha.

And with the size of the portfolio coming down somewhat.

Can you comment on how you guys are thinking.

Thinking about the dividend going forward I guess, there's an offset with prepay speeds slowing but.

Curious to hear your thoughts on how the smaller asset base impacts how you're thinking about the dividend. Thanks, yes.

Yeah. So yeah. This is John .

Yes, so the you know the earnings available for distribution.

The flip side to the pressure on book value is that reinvestment rates are better with wider spreads and slowing speeds certainly help support things because you know.

A lot of our bonds are held at higher.

But prices so.

Those two are both lifts towards AAD, which kind of offsets.

Impacting the smaller portfolio.

And dollar rolls remain.

Relatively attractive going forward, we expect those to.

As the fed.

<unk> their footprint, we expect dollar rolls did feel some pressure, but as of right now they still are pretty supportive to the to earnings. So so for what we see right now and where we are.

Earnings remain.

Support you know pretty well supported.

Okay got it appreciate the comments.

Once again to ask a question please press star one.

One moment please.

Our next question comes from Derek Hewett with Bank of America. Your line is open.

Good morning, everyone I might've missed it earlier, but could you talk about potential additional investment opportunities that would kind of complement your kind of primary agency MBS strategy at this point.

Yes.

John sorry.

Yes.

We've been.

Obviously pre pandemic we were.

Hybrid REIT.

Significant amount of assets in credit and still.

Feel like having.

Some aspect of credit in our book is is would be it would be important. So I mean, we continue to look at.

Options for that they don't involve.

Mark to market financing, so I think that's.

We're hopeful that over the next few quarters, where.

I'm able to.

Sure Mark.

What we are.

Looking at and as that gets closer so.

Yeah No Greg.

Yeah, not there yet but.

But definitely exploring opportunities.

Okay, and then also could you comment on your target capital structure given the.

The year to date decline in common.

Common equity in terms of the percentage of recurring versus preferred.

Sure so pre prepay.

Pre pandemic, we were in the low.

Low twenties percentage of preferred to common.

And I think that that remains kind of our target for now.

So we're.

Looking.

Getting that.

<unk> ratio back in line remains one of our top priorities for this year.

So whether that's either through opportunities with through the ATM or through block trades.

Those open up.

Looking to do that.

As long as it's a benefit to shareholders.

So that's kind of the goal is to get into the low twenty's.

Okay. Thank you.

Okay.

Once again to ask a question. Please press star one one moment.

I am showing no further questions at this time.

Okay.

Okay, well, thank you everybody for joining us and we will.

Talk next quarter. Thanks.

Thank you for your participation participants you may disconnect at this time.

Okay.