Q3 2022 Invesco Mortgage Capital Inc Earnings Call

Today market continued to converge with short term funding rates as indicated in the lower right chart.

Slide six provides detail on our agency MBS investments and the changes in the portfolio during the third quarter, we continued to rotate our lower coupon investments into more attractive higher coupons, expanding our net interest margin and supporting the earnings power of the company. The period end weighted average yield on our agency MBS investments improved from 4.07 <unk>.

<unk> at the end of the second quarter to 465% at the end of the third quarter, capturing a significant improvement in the available returns given wider spreads and higher interest rates during the quarter.

Our our agency MBS investments are well diversified across coupons and we have largely eliminated direct exposure to potential sales from the federal reserves balance sheet, given the reduction in lower coupons, it's almost all of the coupon stack trading at discount prices, we continue to vote specified pool allocation on those characteristics.

Which are expected to perform well and both a premium and discount environment.

Higher turnover states, such as Texas, and Florida, lower loan balances and low FICO stories, typically provide attractively priced prepayment characteristics that lead to faster speeds when trading at a discount and slower speeds when trading at a premium despite expectations for a deterioration in the dollar roll market as the reduction of <unk>.

Demand from the Federal reserve and commercial banks weighs on valuations production coupon TBA remains attractive.

Although we continue to anticipate heightened near term volatility as the federal reserve tightening cycle persists, we believe cheaper valuations on specified pools and TBA represent very attractive investment opportunities with current ROE in the mid to high teens.

Our remaining credit investments are detailed on slide seven with non agency MBS, representing approximately half of the $72 million portfolio, our credit allocation declined modestly during the quarter given paydowns on our credit securities our remaining $45 million of credit Securities are high quality with 87% rated single a.

Our higher 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 favorable unlevered yields.

Positively our remaining commercial real estate loan representing approximately $24 million market value was repaid in full in October .

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 increased to $3 9 billion as of September 30th given the increase in our specified pool holdings and hedges associated with those borrowings also increased to $3 1 billion.

Notional of current pay fixed received floating interest.

Interest rate swaps.

In order to hedge additional exposures further out the yield curve. We continue to hold 700 million net notional of forward starting interest rate swaps with starting dates in 2023.

Consistent with changes in short term funding rates as a result of tightening monetary policy, our weighted average repo cost increased sharply to three 7%.

Positively 80% of our repo costs are hedged by current pay interest rate swaps and the increase in our asset yields as a result of our rotation into higher coupon agency MBS also start to offset the increase in our funding costs.

Economic leverage when including TBA exposure increased during the quarter to five three times debt to equity as a result of our preferred equity repurchases and the decline in book value leverage as of the end of October was roughly unchanged from quarter end.

To conclude our prepared remarks, the third quarter of 2022 presented another extremely challenging environment for agency MBS investors hedged performance for this sector was amongst the worst quarters ever and combined with previous quarters resulted in the worst nine months and 12 months performance as on record.

Positively the significant underperformance experienced over the past year has resulted in very attractive valuations, but historically modest leverage expected to generate mid to high teens Roe on.

On production coupons specified pools and TBA.

In addition, the agency MBS market should benefit from both an anticipated reduction in volatility as the federal reserve near the conclusion of the monetary policy tightening cycle and improving technicals, given the impact of higher mortgage rates on supply.

While we remain cautious given continued near term market volatility. We do believe today's agency MBS valuations, representing an attractive entry point for those with longer time horizons.

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

If you would like to ask a question. Please press star one on your phone on mute and record your name at the prompt again that is star one it'll be a moment further questions to come in thank you.

Yeah.

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

Hi, given that a lot of the weakness in the third quarter kind of happened.

At the tail end of September can you just talk about any portfolio actions you took that might have spilled over into until October and kind of where our portfolio size leverage six.

Okay.

Yeah, Hey, Doug its Brian yet leverages, mostly unchanged since the end of September so.

Around five three times debt to equity, including TBA. So.

Book value performance quarter to date is like John said down roughly four 5%.

So.

We may have modestly reduced.

Exposure to agency mortgages, but not too much to really make it make a big difference.

Sure.

Great.

And then.

Kind of.

Taking steps to reduce the amount of preferred equity, but obviously kind of.

Common book value has continued to fall just talk about where you are trying to get preferred as a percentage of total equity and kind of what other steps you're looking to take.

Yeah, Hey, Doug This is John yes.

We're still obviously committed to getting our capital structure rebalanced and I think.

Thinking about it in the context.

In the 2020% to 25% range for preferreds as is kind of our target.

And we're continuing to look for accretive opportunities both on.

Repurchasing preferreds as well as.

If we can accretively raise.

Common through either the ATM or through <unk>, so any any of those avenues in the near future is.

Is how we're going to go about it.

Great. Thanks.

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

Okay. Thanks.

You guys are obviously, earning a pretty.

Strong.

Spread income, where leverages, where it's at today.

But I guess with some of the tailwind emerging for for agencies that you mentioned in the prepared remarks.

Can you talk about what you would need to see to meaningfully increase your leverage from here.

Order too.

Potentially get some book value appreciation for what the spreads are actually tight.

Yeah, Hey driver it's Brian .

Yes.

We definitely need to see a reduction in volatility I think thats thats the primary.

<unk>.

Thing in the market that we're looking for at this point.

We think that will start to see that and actually.

Paul's comments.

In yesterday's press conference.

Sure.

Talking about potentially more shallow but longer timeframe for.

Monetary policy tightening, we think that that should be.

Volatility reduction.

Or we should see a reduction in volatility as a result of that.

But again, just the near term volatility continues to be relatively high so.

We think over the longer term debt that that should play out.

And the.

If that were to play out and we would we would look to potentially increase.

Average into that but until that happens we're going to remain somewhat cautious.

Okay got it.

And then on the prepayments speeds for the portfolio.

It's still very low.

You mentioned in the prepared remarks, some of the spec pools.

Potentially.

Paying faster when there.

Trading at discounts can you just talk about kind of generally what the sort of projected lifetime speed.

The portfolio would be at this point.

Yes, we think well as we continue to shift into higher coupons thats kind of keeping our.

Our prepayment speeds relatively low because we were buying mostly newly issued mortgages. So we are still seeing Kevin hi, three CPR range.

Yes.

We would expect turnover to be in around the 4% CPR range.

And our rotation into higher coupon should.

Should maybe increase that a little bit, but we would anticipate kind of high single digits.

For a longer term CPR on what we hold currently.

Okay got it I appreciate the comments thank you.

As a reminder to ask a question it is star one.

Our next question comes from Jason Stewart with Jones trading your line is now open.

Good morning.

How do you guys view the political nature of this and at this point.

Yeah.

Hey, Jason its Brian .

Yes, that's a tough one.

I think.

Clearly there were some statements.

Our.

Sentences added to the statement yesterday that.

Seem to be a little bit more dovish than the than the press conference was.

<unk>.

So I think.

Clearly the chairman.

Is likely more hawkish than some of the other committee members and so I think.

His goal.

And the way he views it as that.

It's.

It's easier to be hawkish, now and devilish later than to be dovish, now and potentially loose control of of inflation, Yes, and I think that's yes. This is John .

I agree with all of that and I think.

Be more.

Being slightly more aggressive or more hawkish in the near term is probably.

Helpful. Just in terms of trying to get.

First of all again inflation more.

More quickly, but then also avoiding.

Getting into the next presidential cycle and all of that so I.

I think thats.

Part of the part of the calculus, probably.

The other thing that didn't come up as the hall.

Potential of selling mortgages, which has been an overhang for the mortgage market for a long time, it's sort of.

With all the talk of.

Suppose the dovish pivot we didn't get.

Okay.

<unk> went away a little bit.

Yes, I think.

Going forward I think the possibility of selling mortgages as we go forward is kind of becoming less and less as we have.

As you realize.

Most of the fed holdings are massive discounts and that would create.

Potential paper losses, and things like that that could be you could see easily becoming politicised and I think the fed really wants to avoid any any sort of.

Political battles so.

So I think thats, where it is.

Ed.

I think to Brian's point, though I think the path that seems to be being laid out where the endpoint is kind of more important than the than the past and it's going to be media.

Longer, but but more.

Less aggressive high exit each meeting.

Is potentially good for mortgages and potentially good for volatility decreasing so we view that positively.

Okay got it and then in terms of the TBA is.

Some of your peers used to be a little bit more aggressively than you guys do.

What would cause you to change your view on the way.

Got it Ross.

Yes, I mean, certainly TBA has continued to be pretty attractive.

We've seen deterioration.

As as.

As production comes online in the newer coupons. It's just that we've continued to see newer coupons being created as mortgage rates continue to March higher so.

30 year $5 has and fixes are relatively attractive, but as we start to see more production come out of those coupons, we would anticipate that decline, which is kind of kept a limit on how much we're willing to invest in the TBA market.

But if we were to see.

Things kind of just if we start to see banks start to come back in to the market.

We start to see.

Kind of rates stabilize a little bit.

We would anticipate those higher coupons to remain somewhat attractive so in that environment I think it would make sense to maybe.

Increase the exposure there.

Got it.

Got you okay. Thanks, guys.

There are no other questions in queue at this time.

Alright, well I'd like to thank everybody for joining us and we look forward to meeting you again next quarter. Thank you.

That concludes today's call all participants may disconnect at this time.

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