Invesco Mortgage Capital Inc. Q1 2023 Earnings Call

Welcome to Invesco mortgage capital, Inc. 's first quarter 2023, 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. Please press star followed by the one on your telephone.

A reminder, this call is being recorded now I would like to turn the call over to Greg Seals, and Investor Relations. Mr. <unk> you may begin the call.

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

In 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 that go into 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.

Appropriate reconciliations to GAAP.

Finally, invesco mortgage capital is not responsible for and does not.

Guarantee the accuracy of earnings teleconference transcripts provided by third parties. The only authorized webcast are posted on our website again welcome and thank you for joining US today I'll now turn the call over to John Anzalone, John Alright.

And welcome to Invesco mortgage capital's first quarter earnings call.

Just some brief comments before turning the call over to our Chief investment Officer, Brian Norris and discuss the current portfolio in more detail.

Also joining us on the call.

Q&A, our president Kevin Collins, our CFO , Lee Phegley, our CFO and Dave Lyle.

As we entered 2023 agency mortgages continued its strong performance we saw during the fourth quarter of 2022.

Interest rate volatility eastern.

Patient.

And then the fed tightening cycle, however, favorable market conditions quickly deteriorated and several regional banks failed and concerns around the health of the banking system. Great. These concerns impacted mortgage valuations and interest rate volatility spiked and investors became concerned about the potential liquidation of mortgage assets.

By regulators Swift.

Swift actions by both the federal reserve and the FDIC were effective in reducing Skus and further contagion in mortgage spreads ended the quarter only modestly wider.

Since quarter end regional banking troubles, reignited and mortgage spreads continue to be pressured as volatility remains heightened.

Despite heightened market volatility I E. R. As earnings available for distribution remains strong increasing to $1 50 per share versus $1 46 last quarter.

Our focus on higher yielding higher coupon mortgages in combination with our hedging strategy benefiting from low cost pay fixed swaps drove the increase in EBITDA.

Over the coming quarters, we expect EBITDA to remain well supported as a repo hedge ratio remains elevated.

And forward starting swaps come online.

Importantly, these hedges provide benefits long term as the weighted average maturity of our pay fixed swap portfolio, including the forward starting swaps is over seven years.

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

Given the underperformance of mortgages, our book value ended the quarter and $12.61 down one 4% from last quarter.

Combining the change in book value with our <unk> 40 dividend produced an economic return of one 7% for the quarter.

With continued pressure on mortgage spreads our book value has fallen by approximately 3% since quarter end through last Friday may fit.

Our economic leverage increased modestly during the quarter moving from five three times to five eight times.

At quarter end substantially all of our $5 4 billion investment portfolio was invested in agency MBS.

Maintained a sizable balance of unrestricted cash and unencumbered investments totaling $464 million.

During the quarter, we reduced our dividend from <unk> 65.

Importantly, this dividend reduction was not in response to downward pressure on E. L. E. D has increased the past few quarters, rather reducing the dividend enables us to retain excess earnings to enhance book value and improve our capital structure, while continuing to pay a competitive dividend.

This also allows us to further invest capital into what we see as an increasingly positive environment for the agency mortgage market.

<unk> spreads currently available in agency mortgages and the potential for reduced bank demand should continue to provide good opportunities to invest new capital.

Finally, we expect that the conclusion of the feds.

Tightening cycle will bring about a reduction in volatility providing a tailwind for agency mortgages. So I'll stop here and Brian can you go through the portfolio.

Thanks, John and good morning to everyone listening on the call.

I'll begin on slides four and five which provide an overview of the interest rate and agency mortgage markets over the past year.

After a strong start for fixed income in January interest rate volatility moved higher in February as the pace of disinflation slowed during the first half of March volatility than spike spiked sharply higher given the turmoil in the banking sector before declining into quarter end as measures were taken by the FDIC Treasury and.

Federal reserve to mitigate further distress for banks.

Yields on U S. Treasuries ended the quarter, roughly 40 basis points, lower and maturities from two to 10 years.

Meanwhile, short term rates rose in line with further increases in the expected fed funds rate at the market pushed out anticipated timing of a pause in monetary policy tightening.

As shown in the lower right chart U S. Commercial banks further reduced their holdings of agency MBS during the quarter concurrent 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 into the in the quarter as refinancing activity and housing turnover slowed substantially largely offsetting the decline in demand.

Slide five provides more detail on the agency MBS market and the Upper left chart. We show 30 year current coupon agency MBS performance versus U S. Treasuries over the past 12 months, highlighting the first quarter and Greg exceptional performance in January was offset by underperformance in February and March, but the sector ending the quarter modest.

Weaker.

As shown in the lower left chart nominal spreads remain attractive for current coupon MBS as uncertainty regarding monetary policy further stress on the banking sector and asset liquidations weigh on valuations as indicated in the upper right chart specified pool pay ups ended the quarter largely unchanged while implied financing in the dollar.

Roll market for TBA Securities remained unattractive as shown in the lower right chart.

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

We increased leverage during the quarter from five three times debt to equity to five eight times, reflecting a modestly more positive outlook on the sector with valuations at attractive levels and tightening of monetary policy nearing an end.

In addition, we further diverse diversified our coupon allocation investing proceeds from our ATM activity during the quarter into 30 year, 4% specified pools decreasing our sensitivity to interest rate volatility given purchase prices well below par.

We are largely insulated from direct exposure to asset liquidations from the FDIC as a substantial portion of their holdings are in lower coupon 30 year and 15 year collateral, while we remain in higher coupon 30 year.

In addition, we have no exposure to the deterioration in the dollar roll market for TBA Securities as we were invested exclusively in specified pools at quarter end.

We continue to focus our specified pool allocation on pools that are expected to perform well in both a premium and discount environment.

Although we anticipate elevated interest rate volatility to persist at the fixed income market continues to reflect the uncertainty in the banking sector. We believe current valuations on production coupon agency MBS largely price isn't as uncertainty and represent attractive investment opportunities with current ROE on production coupons in the mid teens.

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

Our credit allocation was largely unchanged during the quarter at $45 million and remains high quality with 87% rated single a or higher.

Although we anticipate limited near term price appreciation. We believe these assets are attractive holdings that there as they are held on an unlevered basis and.

And provide favorable yields.

Our allocation to agency interest only securities detailed on the right side of slide seven remained unchanged as well.

<unk> $81 million a quarter at <unk>.

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 and repurchase agreements collateralized by agency MBS increased to $4 8 billion given the increase in our specified pool holdings and our weighted average repo cost increased to four 9% consistent with changes in short term funding rates due to tightening monetary policy.

Great.

Positively we also increased the hedges associated with those borrowings to four 5 billion net notional of current pay fixed receive floating interest rate swaps, increasing our hedge notional to 93% of borrowings and largely mitigating the impact of higher borrowing rates on the earnings power of the company.

In order to hedge additional exposures further out the yield curve at quarter end, we held $200 million net notional of forward starting interest rate swaps.

Our economic leverage ended the quarter modestly higher at five eight times debt to equity versus five three times at year end, reflecting our positive outlook on agency MBS, given historically attractive valuations and a likely end to the monetary policy tightening cycle.

To conclude our prepared remarks, the first quarter of 2023 was another challenging period for the agency MBS sector as uncertainty regarding monetary policy and its impact on the banking sector cats volatility elevated however are relatively modest leverage combined with a bias for higher coupons that remain at attractive valuations.

And are largely insulated from bank liquidations, along with a notably high percentage of our funding cost hedged leaves us well positioned for the current environment.

Further earnings are well supported at our look with the liquidity position is robust while we anticipate potential near term volatility. We believe current valuations provide a supportive backdrop for long term investment.

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

Thank you we will now begin the question and answer session. If you'd like to ask a question. Please press star one if you need to withdraw your question Press Star two.

Our first question comes from Douglas Harter from Credit Suisse.

Yes.

Thanks, and good morning.

Hoping you could talk about how you kind of see your current leverage and you know what capacity you would have to if any to take advantage of of kind of current widespread.

Yeah, Hey, Doug it's Brian good morning.

No.

We would view current leverage kind of in the midpoint.

Where are we would see our range, we certainly have capacity to add.

We're somewhat hesitant to do that at this point just given continued.

Elevated volatility.

But as that volatility still volatility declines.

We believe given current valuations that would be attractive to do so.

And just on that being attractive to do so do you view that as kind of a longer term.

Attractive carry or do you see kind of meaningful potential for the basis to tighten.

Yes, that's a good question.

I think.

Given what's going on with banks lately.

The question is.

How involved will be with the sector on a longer term basis, we do believe that there'll be.

Somewhat evolved maybe not as much as they had been the last couple of years and certainly the liquidations from the FDIC over the next call it 7% to nine months.

We will likely keep spreads.

Relatively attractive over that time period. So I think we are.

We're probably not.

In an environment, where spreads will go back to where they were call it pre COVID-19.

But they will they should tightened modestly from here over the long term period.

Great I appreciate it thank you.

Our next question comes from Trevor Cranston from JMP Securities.

Okay. Thanks.

Can you talk a little bit more about how you how you guys are thinking about.

In our agency MBS performing going forward as <unk>.

Sales continue to hit the markets and if you think.

Any other any further under performance from here would likely be.

They were concentrated in the coupons that are being sold or or do you think there could be some sort of sympathy widening in the higher coupons as well. Thanks.

Yes, Hey driver, it's Brian good morning.

We do think that there will likely be continued kind of near term volatility as liquidations worked their way through the system.

Yes.

The lower coupons have held in relatively well this month.

<unk>.

But we do think as you know we're only three weeks ended loan liquidations and we still have like I said, another probably seven to nine months of selling so over that time period, we do think that.

Somewhat elevated which is why we're keeping.

Our leverage.

Those liquidation start to work their way.

Through the environment, we think that they will probably makes sense to take advantage of relatively attractive valuations at this point since our move leverage mast out.

Got it okay I appreciate the comments thank you.

Our next question comes from Matthew <unk> from Jones trading.

Hey, guys Matthew on for Jason. This morning. Thanks for taking the question how are you valuing deploying capital in new investments versus share repurchases and then.

In addition to the share repurchases could you talk a breath of preferred a little bit.

Yeah. Thanks This is John .

Yes, I think the decision between new purchases in.

Share buybacks.

For new purchases I think Brian mentioned on the call we're seeing.

Solidly mid mid teens Roe on new purchases.

And depending on.

We see our current book value and as mortgage valuations have been quite volatile.

He has been bouncing around quite a bit so yes I think.

We hit a.

Yeah.

A.

Time win win.

Our valuations are low enough and we will certainly look at.

Buying back.

But.

Given where we're seeing.

<unk> right now or.

We're not quite there yet.

And buying back common.

Further make our common to preferred.

Ratio out of out of line. So theres that hurdle also as far as preferreds go I mean, we are certainly looking I mean, we're aware of that.

The preferred market in general I mean is another story.

Secondary victim of the regional banking crisis, given given that whole sector is mostly made up of financials.

Most mortgage REIT.

<unk> got swept up and not also recently.

So certainly I think Ed.

Sure.

We are seeing them trading now.

<unk> become much more attractive to try to go back and buy some.

The challenge there always is just a limited.

Trading volume that we see on a daily basis been certainly.

We're going to make make every effort to try to repurchase preferred where we can.

Thank you.

Okay.

I'm showing no further questions at this time.

Okay, well, thanks, everybody for joining us and we look forward to.

Meeting again in about three months for our second quarter call. Thanks.

Okay.

That concludes today's conference. Thank you for participating you may disconnect at this time.

Yeah.