Q2 2023 Invesco Mortgage Capital Inc Earnings Call

Welcome to Invesco mortgage capital, Inc. 's second quarter 2023, Investor Conference call all participants will be in a listen only mode into the question and answer session at that time to ask a question. Please press star followed by one on your telephone as a reminder, this call is being recorded now I'd like to turn the call over to Greg Seals, and Investor Relations Mr. <unk>.

You may begin.

Thanks, operator.

All of you joining us on Invesco mortgage capitals quarterly earnings call. In addition to today's press release provided a presentation that covers the topics we plan to address today.

This release and presentation are available on our website invesco mortgage capital back home.

Jason 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.

As you review the disclosures on slide two of the presentation regarding these statements in measures as well.

For the appropriately appropriate reconciliations to GAAP.

Finally, invesco mortgage capital is not responsible for and does not edit nor guarantee.

Guarantee the accuracy of earnings teleconference transcripts provided by third parties the only off.

<unk> Webcasts are located on our website again welcome and thank you for joining US today I'll now turn the call over to John .

John .

Morning, and welcome to Invesco mortgage capital second 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 are president Kevin Collins, our CFO .

Our CFO David <unk>.

Financial conditions improve in the second quarter as equity markets rallied and credit spreads tightened given the Swift resolution of the U S debt ceiling negotiations increased margin expectations in a soft landing in the U S economy, the positive environment across most risk assets was further supported by continued moderation in most of the plays.

These measures led by the decrease in the headline consumer price index, 30%.

Interest rates were sharply higher during the quarter largely reversing the rally spurred by the uncertainty surrounding the regional banking system that we saw during Q1.

The agency mortgage performance generally improved during the second quarter as lower coupon valuations recover the majority of their underperformance in the first quarter.

Coupon valuations improve modestly short dated interest rate volatility remained relatively elevated.

In addition premiums on specified pool collateral declined as a result of higher mortgage rates.

In protection became less valuable.

Increased demand for risk assets like mortgage investors is largely offset by faster than anticipated sales failed bank assets, which it can be specified pool collateral.

The FDIC increase supply caused by stronger housing seasonal.

Against this backdrop, our book value per common share ended the quarter at 11 98, representing a decline of 5% on March 31, and when combined with our 40.

<unk> 40 per share common dividend produced an economic return of negative one 8% for the quarter.

Despite the negative impact on book value I guess earnings available for distribution was resilient.

Creasing slightly to $1 45 to $1 50 last quarter.

Focus on higher yielding higher coupon mortgages in combination with the hedging strategy continues to benefit from low cost pay fixed swaps drove the strength.

Over the coming quarters, we expect Edd remained well supported as we continue to urge nearly all of our repo borrowings.

Importantly, these hedges provide benefits long term as the weighted average mature maturity of our.

Pay fixed swap portfolio is approximately seven years.

Rovs on new investments have also been a positive contributor to EDI benefiting from attractive spreads favorable funding in our legacy swaps.

Our debt to equity ratio ended the second quarter at five nine times up marginally from five as of March 31.

As of the end of the quarter substantially all of our $5 5 billion investment portfolio is invested in agency mortgages, and we retain a sizable balance of unrestricted cash and unencumbered investments totaling $492 million.

<unk> monetary policy tightening cycle is expected to conclude by the end of the year with perhaps one more 25 basis point increase in the federal funds rate reflected in the futures market.

The timing remains uncertain the potential decline in interest rate volatility in conjunction with the end of the monetary policy tightening cycle should be supported for higher coupon agency mortgage valuations.

Further agency mortgage supply and demand technicals are expected to improve in the second half of the year as the liquidation of assets from the FDIC uses conclusion and higher mortgage rates and limited supply.

Personal bank should also gaining greater clarity on the regulatory environment as capital requirements are finalized this could encourage further deployment of capital away from low debt into lower risk weighted assets such as agency mortgages.

Finally valuations in production coupon mortgages remain historically attractive funding capacity is robust.

Together, we believe the decline in industry volatility improving technical environment, combined with compelling valuations and favorable funding conditions should represent an attractive investment opportunity and agency mortgages through the remainder of 2020, Greg I'll stop here and Brian .

Yeah.

Thanks, John and good morning to everyone listening to 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 as John mentioned and as shown in the Upper left chart on slide four yields on U S treasuries largely reversed that move in the first quarter ending the second quarter sharply higher.

Ross the yield curve as the regional bank prices dissipated dovetailing with swiftly are resolved and the economy proved resilient despite persistent tightening of monetary policy.

Short term rates rose in line with further increases in the fed funds rate at the Federal reserve raised the benchmark rate, an additional 50 basis points during the quarter.

And the fed funds futures market reflected the higher for longer policy stance by the federal reserve pushing expectations for cuts into the first half of 2024.

As shown in the lower right chart U S. Commercial banks further reduced our holdings of agency MBS during the quarter concurrent with runoff of the federal reserve's balance sheet, resulting in an increased reliance on money manager in foreign investments that support valuations.

In addition, organic net supply of agency mortgages to the market increased during the quarter as housing seasonal has improved well over 60% of the agency MBS held by the FDIC as a result of recently failed banks were liquidated by the end of the quarter.

The FDIC liquidation has been executed on are significantly faster timeline and the original eight to 10 months expected timeframe and could conclude in roughly half that time.

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 second quarter and Greg <unk>.

Performance in production coupons with volatile during the quarter as the sharp move higher in interest rates in may kind of short term volatility elevated while the decline in volatility in June coinciding with the debt ceiling resolution resulted in a positive environment for valuations.

Current coupon valuations ended the quarter mixed versus hedges modestly outperforming treasuries, while lagging interest rate swap hedges as shown in the lower left chart valuations remain attractive for current coupon MBS as uncertainty regarding monetary policy <unk> interest rate volatility elevated and bank demand remains.

Tepid.

As indicated in the upper right chart specified pool pay ups ended the quarter lower as higher interest rates resulted in lower premiums for prepayment protection.

Hi 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 quarter.

We remain focused and more attractively priced higher coupons, which are largely insulated from direct exposure to assets held by the FDIC and on the federal Reserve's balance sheet. In addition, we have no exposure to the deterioration in the dollar roll market for TBA Securities. As we are invested exclusively in specified pools, we continue to focus.

Our specified pool allocation of pools that are expected to perform well in both a premium and discount environment and modestly improve the quality of our specified pool holdings by increasing our allocation that loan balance stories, given more attractive valuations during the quarter.

Although we anticipate elevated interest rate volatility to persist as the fixed income market continues to reflect uncertainty in near term monetary policy. We believe current valuations on production coupon agency MBS largely priced in this lack of clarity that represent attractive investment opportunities with current gross Roe.

Mid to high teens.

Our remaining credit investments our detailed alongside our agency CMO allocation on slide seven our credit allocation was 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. They are held on an unlevered basis and provide favorable yields.

Our allocation to agency interest only securities detailed on the right side of the slide seven remained largely unchanged as well totaling $78 million a quarter in <unk>.

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

Slide eight details our funding booking quarter and repo.

Repurchase agreements collateralized agency MBS increased to 5 billion given the modest increase in our specified pool holdings as a result of the deployment of proceeds from our common stock ATM program.

And our weighted average repo cost increased to five 2% consistent with changes in short term funding rates due to tightening monetary policy.

Positively we also increased the hedges associated with those borrowings of $4 7 billion net notional of current pay fixed receive floating interest rate swaps, increasing our hedge notional to 95% 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. These forward starting swaps became effective in July and increased our hedge ratio to 99%.

Our economic leverage ended the quarter largely unchanged at five nine times debt to equity versus five eight times at the end of March reflecting our positive outlook on higher coupon agency MBS, given historically attractive valuations and a likely into the monetary policy tightening cycle in the second half of 2023.

Lastly, slide nine provides further detail on our interest rate swap portfolio at the end of the second quarter. We held six 3 billion notional of low cost pay fixed swaps at $1 6 billion notional of received some swaps because the balance of our low cost pay fixed swaps exceeds our repo balance we have an opportunity to grow.

Our investment portfolio through purchases of agency RBS hedged with swap rates, notably below current market rates, resulting in significantly improved Roe versus hedging at current market rates.

Further the weighted average maturity of our pace X interest rate swaps, including forward starters is over seven years, providing substantial benefits for the foreseeable future.

To conclude our prepared remarks, the second quarter of 2023 resulted in an improved environment for agency RBS as interest rate volatility declined modestly while the attractiveness of the asset class asset class remain elevated we.

I believe our bias for more attractively priced higher coupon specified pools leaves us well positioned for the second half of the year given the potential for a further decline in interest rate volatility as the federal reserve seats to conclude monetary policy tightening.

Further earnings remained well supported given our high hedge ratio on our funding costs. Our liquidity position is robust as leverage remains well below historical averages for ACR MBS focused strategy, while we anticipate potential near term volatility as monetary policy tightening concludes we believe current valuations provider.

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 as a quick reminder, if you'd like to ask a question. Please press star followed by one remember to mute your phone and record your name clearly when prompted if you'd like to withdraw that question you May press star two.

Okay and our first question comes from Doug Harter with Credit Suisse. Your line is open.

Thanks, and good morning.

Reference the economic leverage at five nine times.

What is the current leverage to common and which do you view as kind of the the more of a gating factor in terms of your.

Portfolio size.

Yeah, Hey, Doug it's Brian .

Our leverage to comment is right around 10.

Times at this point, so I think yes that's.

That's typically the number that we look at as far as measuring the risk in the portfolio.

Got it and then I guess just with that do you have you know to the extent that we continue to go through bouts of volatility I guess do you have the ability to.

You know to kind of hold onto portfolio size.

Yes.

You know first few days of August continues or do you kind of need to risk manage the portfolio down I'm just I guess, how do you think about that.

Yes.

That number 10 ads has drifted a little bit higher here in the first part of August .

And that's our current numbers so at that level, we still have ample liquidity and have no nature.

You have to readjust the portfolio and you know I think that still gives us plenty of room as volatility declines too to add to leverage as we see fit.

Great and then just on that I mean, I guess, how do you view the current risk.

You know kind of.

How much more widening could we see.

From here given you know given the wide starting levels and now what's your outlook as to how much spreads might tighten there's volatility.

If volatility comes down.

Spreads on higher coupon.

Production coupons are call it.

175, and 200 versus <unk>.

So for swaps.

At this point given the underperformance that we've seen here over the last week.

We're getting pretty close to the to the wise that we saw.

And large shed in October of last year. So.

Yeah.

Maybe call. It another 10 basis points wider we saw a pretty significant demand come in from the major community. So.

We would expect as.

Volatility or to.

Fade from from current levels that we would that we would see that amount of support again.

Great appreciate the answers thank you.

Thank you and our next question comes from Trevor Cranston with JMP Securities. Your line is open.

Hey, Thanks, good morning.

Can you guys talk about where your where you see the the current duration gap on the portfolio and how much.

Our net exposure you have to.

Steeping of the Steepening of the yield curve.

And then I guess the second part of the question.

Could you just give us an update on where you are seeing book volume growth this quarter.

Yeah.

Yes, I'll take I'll take the first part of that on duration gap.

We typically target.

Between a half a year in one year.

And that number will move around as interest rates.

Change so given the sell off that we've seen we're probably towards the higher end of that range from a yield perspective, we tried to stay relatively neutral.

Yes.

The swap book that we have the reason that we have such longer dated swaps as just given that the.

The profile of the mortgages that we own so.

Yeah, we stay relatively neutral from that perspective.

And then from a book value.

But we put a range out for the end of July which showed relatively unchanged from quarter end.

There has been some other performance certainly as we start into the month of August here as rates have moved higher and this volatility has also increased mortgages had underperformed.

Okay. Thank you.

Okay.

And I'm showing no further questions in queue.

Okay, well. Thank you everybody for joining us on the call and we look forward to speaking again next quarter. Thanks.

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