Q4 2022 Invesco Mortgage Capital Inc Earnings Call

Welcome to Invesco mortgage capital, Inc, fourth quarter, 2022 Investor Conference call.

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 as a reminder, this call is being recorded.

I would like to turn the call over to Matt sites and Investor Relations. Mr. Sites, you may begin the call.

Thanks, operator and to all of you joining us on Invesco mortgage capitals quarterly earnings call.

Addition to today's press release, we have provided a presentation that covers the topics we plan to address today. The press release and presentation are available on our website Invesco mortgage capital Dot Com. This information can be found by going to the Investor Relations section of the website.

Our presentation today will include forward looking statements and certain non-GAAP financial measures. Please review the disclosures on slide two of the presentation regarding these statements in measures as well as the appendix for the appropriate reconciliations to GAAP.

Finally, invesco mortgage capital is not responsible for and does not edit nor guarantee the accuracy of our earnings teleconference. Transcripts provided by third parties. The only authorized webcasts are located on our website 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.

To 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, and our CEO Dave Lyle.

Financial conditions began to ease during the fourth quarter. Despite a pair of 75 basis point increases to the fed funds target rate as investors began to anticipate and then to the epilepsy tightening cycle.

While still at elevated levels inflation as seen through the CPI and PPI indices is well below its recent highs and has begun to ease risk markets responded favorably as equity markets improved most credit spreads tightened and volatility measures moderated after facing the most challenging environment in <unk>.

For a decade during the first three quarters of 2022 mortgage performance rebounded during the fourth quarter and into the first quarter of 2023 with current coupon agencies outperforming treasuries and interest rate volatility came off its recent highs.

For the quarter I'd be ours earnings available for distribution remains strong coming in at $1 46 versus $1 39 last quarter.

Patient into higher yielding higher coupon mortgages. In addition to substantial hedging a borrowing cost with interest rate swaps drove this increase and AAD.

Over the coming quarters, we expect to continue to be supported as our repo hedge ratio remains elevated as forward starting swaps come online.

Accordingly, these hedges provide benefit for the long term as the average maturity of our swap book is over seven years.

Our ROE is on new investments have also been a positive contributor to EBITDA as the wider spreads on new purchases are attractive and we enjoyed the benefit of having retained low coupon legacy swaps.

While mortgage performance has been positive since the beginning of the fourth quarter, both interest rates and mortgage markets remain volatile.

Value was largely unchanged in the fourth quarter and combined with our 65 cent dividend resulted in an economic return of approximately 5%.

Given our strong performance to begin 2023 book value has improved by approximately 4% since year end through February 17.

Our economic leverage remained unchanged during the quarter, finishing at 553 times at.

At quarter end substantially all of our $4 8 billion investment portfolio was invested in agency MBS and we maintain a sizable balance of unrestricted cash and unencumbered investments totaling $528 million.

While mortgage valuations look attractive given our relatively widespread particularly in higher coupons are outlook for mortgages remained somewhat cautious mortgage performance has been highly correlated with changes in short dated interest rate volatility, we expect volatility to remain elevated while the near term path of fed funds remains uncertain.

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Once the feds path becomes clearer mortgages should enjoy cigna.

Significant tailwind as volatility false.

I'll stop here and Brian will go through the portfolio.

Thanks, John and good morning to everyone listening to the call I'll begin on slide four which provides an overview of the interest rate and agency mortgage markets over the past year, but during the fourth quarter interest rate volatility remained historically elevated as inflation unemployment data releases shaped market expectations for the path.

Of monetary policy in 2023.

The yield curve continued to invert as yields on U S treasuries with maturities, one year or less increase between 75, and 135 basis points, while maturities longer than one year were largely unchanged, reflecting expectations that the current cycle of monetary policy tightening by the federal reserve is nearing its conclusion.

In addition expectations for easing monetary policy has intensified since the end of the third quarter with substantial cuts in the fed funds rate price deck for 2024 as indicated in the bottom left chart as shown in the lower right hand chart U S. Commercial banks further reduce their holdings of agency mortgages during the fourth quarter.

Current with runoff of the federal reserve's balance sheet, resulting in increasing reliance on money manager and foreign investment for the sector.

Positively the organic supply of agency mortgages to the market continued to decline in the quarter as refinancing activity and housing turnover slowed substantially given the sharp increase in mortgage rates in 2022, largely offsetting the significant decline in demand.

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

Despite 2022 being an extraordinarily challenging environment for financial markets and the agency MBS in particular.

Mortgage performance rebounded during the fourth quarter and has continued its more positive trend this year.

In the upper left hand chart, we show 30 year current coupon agency MBS performance versus U S treasuries and 2022, highlighting in the fourth quarter and Greg.

After underperforming for most of October agency, MBS valuations rebounded as interest rate volatility declined from its peak and interest rates fell.

The sector performed very well in November as attractive valuations and limited supply encouraged investor demand.

Weakened modestly in December as the decline in interest rate volatility reversed and liquidity decreased into year end.

As shown in the upper right chart.

Spot pool pay ups improved modestly during the quarter as investor demand increased while implied financing in the dollar roll market for TBA Securities continued to deteriorate as indicated in the lower right chart.

Slide six provides detail on our agency MBS investments and the changes in the portfolio during the quarter.

We continued to rotate lower coupon investments into more attractive higher coupons.

Landing, 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 465% at the end of the third quarter to $5 two 6% at the end of the fourth capturing a significant improvement in available returns given more attractive value.

<unk> and higher coupons at the inverted yield curve and elevated front and interest rate volatility provides higher yields for shorter duration investments.

As you can see in the Upper left chart. Our agency MBS Holdings are focused primarily on current production coupons and our exposure to policy adjustments in regards to the federal reserve's balance sheet has significantly reduced given it's primarily focused in lower coupons.

In addition, given the continued deterioration in the dollar roll market for TBA Securities, we fully exited our TBA position during the quarter and rotated the balance into specified pools. We continue to focus our specified pool allocation on those characteristics, which are expected to perform well in both a premium and discount environment.

States, such as Texas, and Florida, as well as borrowers with low loan balances typically produce faster prepayments when trading at a discount and slower speeds when trading at a premium.

During the quarter, we increased allocations to credit stories, such as high LTV and low credit score, which should perform well as the economy and home price depreciation slows in 2023.

Although we continue to anticipate elevated front and interest rate volatility as monetary policy evolves. We believe current valuations on production coupon agency MBS represent attractive investment opportunities with current Roes in the mid teens.

Our remaining credit investments our detailed alongside our agency CMO allocation on slide seven.

Our credit allocation declined during the quarter given the full repayment of our $24 million commercial real estate loan and further paydowns on our credit securities.

Our remaining $46 million of credit Securities are high quality with 87% rated single a or higher.

Though we anticipate limited near term price appreciation. We believe these assets are attractive holdings as they are held on an unlevered basis and provide favorable yields.

We have continued to rotate paydowns on our credit investments and to lower coupon fixed rate agency interest only securities, which totaled $85 million and are detailed on the right side of slide seven.

These holdings also provide an attractive unlevered yield and benefit from the current slow prepayment environment, given minimal housing turnover and limited refinance activity.

Lastly, slide eight details our funding book at quarter end.

Repurchase agreements collateralized by agency MBS increased to $4 2 billion given the increase in our specified pool holdings and our weighted average repo cost increased to four 2%.

Consistent with changes in short term funding rates due to tightening monetary policy.

Positively hedges associated with those borrowings increased to $33 5 billion net notional of current pay fixed receive floating interest rate swaps, increasing our hedge notional to 81% of borrowings.

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 as of year end.

Since year end, our hedge notional percentage has increased to 90% at $500 million of our forward starters became effective.

Our economic leverage ended the quarter unchanged at five three times debt to equity and since quarter end has moved modestly higher given additional purchases of agency MBS specified pools funded via repurchase agreements.

To conclude our prepared remarks, 2022 was an extremely challenging year for the agency MBS sector looking forward higher interest rates and wider spreads present, an attractive environment for investors in the sector should also benefit from a reduction in front end volatility, while we remain cautious given continued uncertainty.

Regarding monetary policy, we do believe today's agency MBS valuations represented an attractive entry point for those with longer time horizons.

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

Thank you.

I would like to ask a question press the star followed by the one on your telephone.

Our first question today comes from it.

Doug Harter with credit Suisse. Your line is open.

Hi, Thanks, I was hoping you could.

Talk about how you're thinking about the dividend.

In light of.

You know kind of available returns you see her.

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But that you're currently generating.

Yeah, Hey, Hey, Doug, It's John Yeah, as I mentioned earlier.

Earnings available for distribution remains well supported.

For the reasons I mentioned.

Payout rate as determined by our board and when setting the dividend we look at a number of factors.

One of the things we'll be looking at is how competitive our payout rate is versus peers balanced with a desire to support book value. So that's.

That's the balance will be we'll be looking at but there's plenty of time until we need to make that decision by the end of the quarter.

Great and I apologize, if you said, but I guess.

Now obviously, it's bounced around but you know kind of where do you see.

What kind of incremental returns on new investments today.

Yeah, Hey, Doug its Brian ROE today.

We've seen some underperformance in agency mortgages here in February so ROE are a little bit improved there probably in the mid teens at this point.

I would say at the end of January it was more low to mid teens and we've seen some improvement since then.

Great. Thank you.

Thank you. The next question comes from Trevor Cranston with J M P.

<unk> Securities Your line is open.

Hey, Thanks, good morning.

Can you talk about looking.

Looking at the.

The hedge position.

Looked like it changed.

Changed all that much quarter over quarter.

As the portfolio moved up in coupon.

Could you guys talk generally about how you guys are thinking about your rate positioning.

As we as we've done to date.

Yeah, Hey driver its Brian .

Typically we try to eliminate.

Our exposure to both changes in interest rates and changes in the yield curve. So our swap book is kind of across the yield curve as John mentioned.

Weighted average maturity is over seven years, so we feel like that fairly closely closely matches.

The duration of our securities.

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So overall, we think our we believe our interest rate exposure is relatively muted I would say we've given the backup in rates that we've seen over the last couple of weeks, we've we've moved a little higher.

But not you know, it's probably a half a year to three quarters of the year duration gap.

Okay got it.

And then I was curious about.

The common thread.

Adding some <unk> to the portfolio.

Can you expand a little bit on kind.

The value of those add to the portfolio and how you see the sort of ROE potential of low coupon io versus potentially just having more pools.

Yes, we feel like the.

The agency Io position does help hedge some of the exposures that we have in the in the specified pool book.

Unlevered yields are pretty attractive in the in the high single digits, we're not levering those securities. So we kind of view the agency Io book Similarly to the to the credit book, we're allowing it to to sit there on an unlevered basis still earn a relatively attractive yields, but again just kind of hedges.

The exposures that we see in the in the specified pool book.

Got it okay. Appreciate it thank you.

Thank you there are currently no other questions at this time.

Okay, well I.

Appreciate everything we all appreciate everybody dialing in for the call and look forward to you joining us next quarter. Thanks.

Thank you that concludes today's conference and thank you for participating you may disconnect.