Q1 2022 Invesco Mortgage Capital Inc Earnings Call

MBS performance versus swap hedges since the third quarter of 2021, and generic 30 year to two 5% and 3% coupons highlighting the first quarter of 2022 and gray all.

All three coupons underperformed sharply during the quarter given escalating volatility due to the significant changes in expectations for monetary policy and the Russian invasion of Ukraine.

Minutes from the December <unk> meeting, where we released in early January setting the table for a much more rapid shift from quantitative easing to quantitative tightening as expectations for the timeline of balance sheet normalization accelerant accelerated measurably.

Initially the market was expecting a much longer delay similar to the end of Q3.

Furthermore, market concerns on the potential for sales from the fed's balance sheet sparked additional deterioration in the agency MBS valuations and by the end of April the asset class had experienced its most significant cheapening since the financial crisis with 30 year current coupon nominal spreads of treasuries, increasing over 100 basis points.

Since may of 'twenty, one shown in the bottom left chart.

Sharply higher mortgage rates have pushed refinancing activity near the lows of the past 20 years and as a result, the value of prepayment protection on specified pools has collapsed as indicated by the decline in pay ups in the top right chart.

In the bottom right chart.

Implied financing rates on lower coupon TBA increased at fed purchases declined given the conclusion of net purchases.

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 half of the year.

Given yesterday's epilepsy meeting and Chairman Powell Press conference. The Federal Reserve is set to reduce the agency MBS portion of its balance sheet via Paydowns, beginning with a monthly cap of $17 5 billion in June which will increase to $35 billion in September .

Mortgages responded well to the announcement as the ramps of the $35 billion cap is shallower than expected leading to more reinvestment in the coming months.

In addition, there was no mention of asset sales from the balance sheet, what's the market interpreted as a signal that potential sales are far into the future and not currently being contemplated by the fed.

Slide six provides detail on our agency MBS investments and the changes in the portfolio during the first quarter, we significantly reduced our allocation to agency MBS through outright sales of lower coupon securities and Paydowns on the total portfolio given the continued challenges in the sector, while the earnings capacity of the company remained robust.

Through attractive funding rates.

And relatively slow prepayment speeds.

In addition, we continued to actively manage our overall allocation, reducing our exposure to 30 year to two 5% and 3% coupons in favor of those higher than the coupon stack. While also rotating a portion of our holdings into more attractive collateral stories, such as loan balance which provides benefits in both premium and discount <unk>.

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Despite moving up in coupon the weighted average pay up on our specified pool holdings fell to 0.3 points as demand for prepayment protection declined given falling prepay speeds and higher mortgage rates.

Modest increase in TBA allocation in the bottom chart as a result of the smaller specified pool portfolio and we expect to decrease our allocation to TBA in subsequent quarters, given the expectation for deterioration in the dollar roll market.

The weighted average yield on our agency MBS holdings increased 47 basis points to 254% as of quarter end as our rotation into higher coupons and modestly slower prepayments on our specified pools supported the earnings power of the portfolio.

Though we have seen a decline in the attractiveness of the dollar roll market and lower coupon TBA production coupon TBA remains attractive and we believe wider spreads on specified pools represent attractive investment opportunities.

Current ROE on production coupon dollar rolls are in the mid to high teens, while specified pool Roes are in the low teens we.

We believe this trend will continue in the coming months as dollar roll and specified pool Roe converge.

Slide seven is an update on activity in our agency MBS portfolio through the end of April .

As indicated in the chart on the top we have accelerated the reduction in exposure to the asset class, which largely began as the fed pivoted to a significantly tighter monetary stance in the fourth quarter of 'twenty one.

In addition to the reduction in the overall allocation, we have diversified the coupon distribution substantially as the rise in mortgage rates since year end provided an opportunity to invest proceeds of sales and lower coupons into more attractive options higher than the coupon stack given new production in those coupons.

Despite the reduction in the portfolio the rotation into higher yielding production coupons slowing prepayment speeds and an attractive environment in funding markets continues to continues to support earnings available for distribution.

Our remaining credit investments are detailed on slide eight with non agency MBS, representing 63% of the $98 million portfolio, our allocation to credit securities remained stable during the quarter with no asset sales and limited price movements overall, our $70 million.

Hours 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 as 100% are held on an unlevered basis and provide attractive unlevered yields.

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

Repurchase agreements collateralized by agency MBS declined to $5 8 billion as of March 31, given the reduction in our specified pool holdings and hedges associated with those borrowings also declined to $4 5 billion net notional pay fixed receive floating interest rate swaps.

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 23 basis points to 37 basis points and have continued to climb higher as the funding.

Market prices and tighter monetary policy in the coming months, our economic leverage when including TBA exposure increased modestly during the quarter to six five times debt to equity due to the decline in book value.

Post quarter end the reduction in the portfolio product economic leverage modestly below six times debt to equity as of April 30, as we remain focused on reducing risk in the agency MBS sector.

To conclude our prepared remarks significant challenges in the agency MBS market persist and we are actively reducing risk in order to preserve book value maintain flexibility and ensure we are well positioned to capitalize on opportunities when downward pressure on valuations eases.

The worsening supply and demand technicals are likely to pressure spreads wider in the near term as we believe fair value given balance sheet runoff is approximately 10 to 15 basis points wider from current levels, while outright sales from the fed's balance sheet will likely remain an option as inflation remains elevated we do not believe this to be a 2022 event.

And we'd expect to outright sales to remain a low probability event, if inflation moderates as expected in the second half of the 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 as a quick reminder, if you'd like to ask a question. Please press Star then one.

Remember to mute your phone and record your name when prompted if you'd like to withdraw. Your question you May Press Star two.

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

Hi, This is John Peeler choppy on for Doug.

I guess first question now with the smaller asset base.

What is the outlook for the future of the dividend now as you could see pressure there with meeting higher terms.

Alright, okay.

First of all our dividend policy set by our board based on where we expect.

Earnings available for distribution to be over the coming quarters.

Always difficult to comment on any potential dividend decisions in advance.

That said.

It came in well above the dividend this quarter at 12 <unk> versus <unk>.

Mainly because of slowing speeds and higher reinvestment rates as we rotated into higher coupons.

Particularly production coupon dollar rolls. So looking ahead over the next couple of quarters.

We anticipate that the impact of <unk>.

<unk> will be.

Or will be impacted by lower leverage, but also by higher reinvestment rates offered by wider mortgage spreads as we continue to rotate into higher coupons.

We also expected as the mortgage basis becomes more attractive going forward, we will look to begin to lever up again, which would also be supportive.

So.

That's kind of where we see things going.

Okay.

Got it. Thank you and then second question would just be I know.

Kind of a crystal ball question, but we've talked about this last quarter, where we thought how much wider spreads can go I feel like the commentary now this quarter is roughly similar even though we've already seen them kind of widen beyond that.

What's your timeline and what's kind of your policy right now around kind of book value protection wall spreads are kind of in this volatile space and then where our marginal dollars looking to go.

And when do you think youll.

We can start to expect leverage to be taken up.

Yes. Thanks this is Brian .

Difficult question to answer clearly Theres a lot of volatility the fed just met.

Yesterday with their announcements so mortgage like I said mortgages responded pretty well to that just because there is.

Going to be more demand over the next few months than what was originally expected so spreads are going to be fairly well supportive.

Supported during that timeframe, but.

We still think that.

Supply and demand is going to be challenged as we move forward.

And.

Spreads are going to react to.

The probability of asset sales in the future so.

That probability has come down some mortgages have done.

But if inflation remains elevated and we expect that that probability will increase in the future and that spreads would widen as a response to that so.

It's tough to say I think right now just given the volatility and uncertainty about the fed path.

We're going to remain pretty.

Pretty conservatively positioned until that becomes more clear.

Great.

Oh, yes.

The marginal dollar is going to likely go into production coupons, which are more like 30 year fours and four fives currently.

Got it thank you.

Yes.

And our next question comes from adjacent Stewart with Jones trading your line is open.

Hi, good morning, Thank you.

Was hoping you could give us an update on your thoughts around portfolio diversification if that.

Either a timeline or an asset class that sort of coming to fruition there.

Yes, we do yes.

Yes.

First of all we still believe in the hybrid model.

And obviously benefits that come from asset diversification are very important.

So we're still.

Looking at different opportunities the objective with any new investment strategy is going to be to mitigate some of the risks inherent in our current portfolio.

So we're looking at opportunities that require lower leverage and in particular, avoiding short term mark to market leverage.

Strategies to contribute a greater book value stability would also be beneficial and of course expect to returns need to be attractive. So.

No.

Thats kind of what we're looking at.

But nothing to report as of right now.

Okay Fair enough and then I wanted to follow up on the TBA dollar roll comments that you made it sounds like you expect production coupon rolls to remain strong up until some point is that point when the fed is actively out of the market and letting runoff happened. So in June or do you think dollar rolls could persist in that mid teens post.

June .

Our production coupons.

Yes, we think production coupon dollar rolls can remain pretty well supported I think.

These these bonds are really just now being produced just given how fast the mortgage rate has moved up.

So for four and a half.

And eventually even fives, there's just not a lot of bonds out there right now and so that's the reason why the TBA is so attractive because theres a lot of demand.

For exposure there, but there's just no bonds to deliver so we.

We think that that can persist for.

Quite a bit.

And the other benefit is that brand new bonds don't pay very fast right. So it's going to take some time for those to ramp up.

And to higher CPR, which would which would then lead to a less attractive.

<unk> environment, So we think.

I don't want to get too far ahead of myself, but over the next quarter or two that they can remain relatively attractive.

Okay, Great and I guess just to put a point on that your comment was you expect the TBA portfolio to be smaller.

Versus vis vis <unk> <unk>.

<unk> and <unk> and <unk>, what's your point was.

Sure.

Yes, that's right, yes, yes, I mean, the overall portfolio is smaller too right.

So we've reduced TBA, just given that we're no longer investing in those lower coupon.

TBA and we've moved higher coupon.

But given the overall size of the portfolio is smaller than we expected the TBA will follow suit.

Got it great. Thanks, a lot.

Yes.

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One moment to see if you have any more questions.

Okay.

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Okay.

Okay well.

Thank you everybody for joining us on the call and look forward to speaking to you next quarter. Thanks.

Thank you and that concludes today's conference you may all disconnect at this time.