Q3 2024 Invesco Mortgage Capital Inc Earnings Call
Speaker Change: Welcome to the Investcome Mortgage Capital 3rd Quarter 2020 for earnings call. I'll participants will be in a listen only mode into the question and answer session. At that time to ask a question, press the star of probably by one on your telephone keypad.
Speaker Change: Also, as a reminder, this call is being recorded. Now, with I turn the call of the Greg Seals and Investor Relations, Mr Seals, you may begin.
Speaker Change: Thanks operator and all of you joining us on a best-in-one mortgage capital's quarterly earnings column. In addition to today's press release, we have provided a presentation that covers the topics we've planned to address today. The press release and presentation are available on our website at best-in-one mortgagecapoff.com.
The information can be found by going to the investigation section of the website. Our presentation today will include forward-looking statements in certain non-dap financial measures.
Please review the display of your sunlight to the presentation regarding these statements and measures as well as the epitomex for the appropriate reconciliation recap. Finally, in this bill market cap, it also now responds before and does not edit more guarantee the accuracy of our earnings teleconference transcripts provided by third parts.
Speaker Change: The only authorized webcast for the K-T-Hunter website
Speaker Change: Again, welcome. Thank you for joining us today. I'll now turn the call over to IVR's CEO, John Anzalone.
John Anzalone: Thanks, Craig. Good morning and welcome to Invesco Mortgage Capital's third quarter earnings call.
John Anzalone: I'll provide some brief comments before turning the call over to our Chief Investment Officer, Brian Norris, to discuss our portfolio in more detail.
John Anzalone: Also joining us on the call this morning for Q&A is our president, Kevin Collins, our COO, Dave Lyle, and our recently appointed interim CFO, Mark Gregson, so welcome, Mark.
Brian Norris: During the quarter, interest rates dropped sharply across the curve as investors reacted to cooling inflation and the potential for slower economic activity signaled by a weakening labor market. These factors also led to a repricing of the market's expectations of future monetary policy.
Brian Norris: Following the FOMC's initial 50-basis point reduction in its benchmark rate in September,
John Anzalone: The federal funds futures market reflected an expectation that the target rate would be reduced by an additional 50 to 75 basis points.
John Anzalone: during the balance of 2024 with another 100 to 125 basis points worth of cuts priced into 2025.
John Anzalone: Against this backdrop, agency mortgages outperformed treasuries during the third quarter.
John Anzalone: Moderating industry volatility and the steepening of the yield curve spurred demand for agency mortgages with lower coupons performing better than higher coupons as a sharp decline in interest rates mitigated demand for coupons trading at a premium to par.
John Anzalone: Overall, prepayment speeds remained at very low levels given limited housing activity and elevated mortgage rates. The speeds increased notably on higher coupons in September as a decline in mortgage rates over the summer led to a surge in refinancings in more recent originations.
John Anzalone: Given the decline in mortgage rates and upward pressure on prepayments, premiums on higher-coupon specified pool collateral increased modestly, while implied volatility via the dollar roll market
John Anzalone: or implied financing via the dollar rule market for TVA investments remained relatively unattractive throughout the quarter. Agency CMBS risk premiums moved modestly wider, increasing the relative value versus agency mortgages.
John Anzalone: The positive environment for mortgages contributed to a 1.1% increase in book value per common share to $9.37.
John Anzalone: Combined with our $0.40 common stock dividend, this resulted in an economic return of 5.4% for the quarter.
John Anzalone: As we enter the fourth quarter, uncertainty around the U.S. elections and the future path of monetary policy has caused a sharp increase in both Treasury yields and interest rate volatility, which has put heavy pressure on mortgage valuations.
John Anzalone: As of last night, our estimated book value is down approximately 5.8% since 9.30.
John Anzalone: Our debt-to-equity ratio ended the second quarter at 6.1 times, up from 5.6 as of June 30th, while our economic debt-to-equity ratio increased from 5.9 times to 6.1 times quarter over quarter.
John Anzalone: As of the end of the quarter, our $5.9 billion investment portfolio primarily consisted of $5.2 billion of agency mortgages and $0.7 billion of agency CNBS.
John Anzalone: And we continue to maintain a sizable balance of unrestricted cash and unencumbered investments totaling $520 million.
John Anzalone: For the quarter, earnings available for distribution for common share was $0.68 compared to $0.86 in the second quarter. This decrease primarily reflects reduction in our effective net interest income related to changes in the size and composition of our hedging portfolio.
John Anzalone: Yesterday, we announced our intention to redeem our Series B preferred shares on December 27th, which will help optimize our capital structure and reduce our dividend obligations going forward.
John Anzalone: Looking ahead, the recent disinflationary trend in economic data suggests that the Federal Reserve can continue to ease monetary policy in the coming months as the need for restrictive monetary policy declines.
John Anzalone: This easing, combined with the end of the U.S. election cycle, should lead to a steeper yield curve and lower industry volatility, creating a favorable environment for agency mortgage investments.
John Anzalone: However, if the disinflationary trend reverses and the labor market and economic growth improve, expectations for monetary policy could shift, posing a near-term risk. Additionally, short-term funding pressures into the U.N. could impact demand for the sector.
John Anzalone: Despite these near-term risks, we are constructive on the sector as agency mortgage performance stands to benefit from normalization of monetary policy given attractive valuations and supportive supply and demand technicals.
John Anzalone: We also remain constructive on agency CMBS, as we expect a gradual increase in new issuance to be met with adequate investor demand, as the sector offers value relative to other fixed income investments, given its attractive pre-payment protection and return profiles.
John Anzalone: Now I'll turn the call over to Brian to go through the portfolio.
Brian Norris: Thanks, John, and good morning to everyone listening to the call. I'll begin on slide 4, which provides an overview of the interest rate and agency mortgage markets.
Brian Norris: As shown on the chart in the upper left, U.S. Treasury yields declined across the yield curve during the third quarter, as two-year yields were 111 basis points lower, while 10-year and 30-year yields declined 61 and 44 basis points, respectively.
Brian Norris: The chart on the bottom left provides Fed Funds futures market pricing since year-end. Due to ongoing disinflation and a weakening labor market, investors priced in two more 25 basis point cuts in the Fed Funds rate for 2024 and 2025 by the end of the third quarter.
Brian Norris: compared to the end of the second quarter.
Brian Norris: By the end of October, investor expectations moderated due to a stronger-than-expected September employment report, raising concerns that monetary policy may remain tighter for longer.
John Anzalone: Elevated monetary policy uncertainty and the strength of the economy has caused interest rate volatility to rise sharply, leading to agency mortgage underperformance in October.
John Anzalone: The chart in the upper right reflects changes in short-term funding rates since year-end.
John Anzalone: During the third quarter, funding rates declined in line with expectations for near-term monetary policy easing, but repo rates exhibited substantial volatility at quarter end, given heavy U.S. Treasury supply and increased demand for repo.
John Anzalone: Positively, the repo market normalized in October, although spreads have remained modestly wider given concerns regarding future treasury supply, election, and monetary policy uncertainty, and the risk of renewed funding pressures into year-end.
John Anzalone: Lastly, the bottom right chart details agency mortgage holdings by the Federal Reserve and U.S. banks.
John Anzalone: Runoff of the Fed's balance sheet continues, with agency mortgages declining by approximately $15-20 billion per month, while U.S. banks added modestly to their balance sheets.
John Anzalone: Slide 5 provides more detail on the agency mortgage market.
John Anzalone: In the upper left chart, we show 30-year current coupon performance versus U.S. Treasury since year-end, highlighting the third quarter in gray.
John Anzalone: Current coupons outperformed during the quarter, as interest rate volatility declined and the yield curve steepened, improving investor demand. Since the end of the quarter, however, increased interest rate volatility and a bear flattening yield curve led to sharp underperformance in the sector.
John Anzalone: Nominal spreads on current coupons return to year-to-date-wise and remain historically attractive, as ongoing interest rate volatility is limiting demand.
John Anzalone: Specified pool payouts improved in the third quarter due to the decline in mortgage rates, but have partially reversed as the abrupt increase in interest rates has led to less demand for prepayment protection.
John Anzalone: Lastly, as shown in the lower right chart, the dollar oil market for TBA securities became relatively unattractive again, with implied funding rates higher than sober for most coupons.
John Anzalone: We continue to prefer specified pools over TBA, given their more predictable prepayment behavior and favorable funding yield levels.
John Anzalone: Slide 6 details our agency RMDS investments and summarizes investment portfolio changes during the quarter.
John Anzalone: Our agency RMBS portfolio increased 12% quarter over quarter as we invested proceeds from ATM issuance into higher coupons.
John Anzalone: We continue to rotate a portion of our lower coupons into agency CMBS as the relative value improved given tighter spreads and discount agency RBS.
John Anzalone: Overall, we remain focused in higher coupon agency RMES, which should see greater benefit from decline in interest rate volatility and are largely insulated from direct exposure to assets held by commercial banks and on the Federal Reserve's balance sheet.
John Anzalone: We focused our specified pool allocation on prepayment characteristics that are expected to perform well in both premium and discount environments, with our largest concentration in lower loan balance collateral, given more predictable prepayments.
John Anzalone: In addition, during the quarter, we rotated our $200 million notional TBA position into higher coupon-specified pools, as implied funding levels in the dollar roll market deteriorate.
John Anzalone: Although we anticipate interest rate volatility to remain moderately elevated in the near term, we believe current valuations on Production Coupon Agency RBS largely reflect this risk and represent attractive investment opportunities.
John Anzalone: with current gross ROEs in the mid to high teens.
John Anzalone: Slide 7 provides detail on our agency's CMDS portfolio. We purchased $214 million in the third quarter, bringing our exposure to approximately 12% of our total investment portfolio.
John Anzalone: We believe Agency CMBS offers many benefits, mainly through its prepayment protection and fixed maturities, which reduce our sensitivity to interest rate volatility.
John Anzalone: Pros to ROEs on our new purchases were in the low double digits. ROEs.
John Anzalone: And we have been disciplined on adding exposure only when the relative value between agency CMBS and agency RMBS accurately reflects their different risks.
John Anzalone: Financing capacity has been robust.
John Anzalone: as we have been able to finance our purchases with multiple counterparties at attractive levels.
John Anzalone: We will continue to monitor the sector for opportunities to increase our allocation as they become available Recognizing the overall benefits of the portfolio as the sector diversifies risks
John Anzalone: associated with an agency RMES portfolio.
John Anzalone: Our agency's CMO allocation is detailed alongside our remaining credit investments on slide 8. Our allocation to both agency interest-only and credit securities remained unchanged.
John Anzalone: $73 million allocated to HCIO and $18 million allocated to credit at quarter end. Although we anticipate limited near-term price appreciation in these investments, we believe they provide attractive yields for unlevered holdings, with returns in the high single digits.
John Anzalone: Slide 9 details our funding and hedge book at quarter end.
John Anzalone: Repurchase agreements collateralized by HCMBS increased from $4.3 billion to $5.2 billion, reflecting the increase in our equity base and assets, and our notional pay-fix interest rate swaps increased as well, from $3.9 billion to $4.3 billion.
John Anzalone: Given the smaller increase in our hedge notional, the ratio of our hedge notional to borrowings decreased quarter over quarter to 83% from 92% as we increased our position in longer duration treasury futures.
John Anzalone: In addition, the sharp decline in interest rates led to further repositioning of the swap book, as the interest rate sensitivity of our assets decreased, warranting a similar decrease in the weighted average maturity of our hedges.
John Anzalone: Reflecting this change, the weighted average maturity of our swaps declined from 7.5 years at the end of the second quarter to 5.4 years, resulting in an increase in the weighted average coupon on our paid fixed swaps from 1.22 percent to 1.37 percent.
John Anzalone: Economic leverage ended the quarter at 6.1 times debt-to-total equity, up from 5.9 times at the end of June, while our debt-to-common equity declined.
John Anzalone: from nearly 9.5 times to 9.1 times at quarter end. The increase in our total equity leverage and decline in common equity leverage highlights the positive impact of our improving capital structure.
John Anzalone: Subsequent to quarter end, we announced our intention to call our Series B preferred equity in late December, which will further improve our capital structure as we enter 2025.
John Anzalone: To conclude our prepared remarks, despite strong results in the third quarter, financial markets have been quite volatile in recent weeks as investors become increasingly concerned about the outcome of the election and its impact on near-term fiscal policy, while also continuing to debate the path and magnitude of monetary policy easing.
John Anzalone: A sharp decline in interest rates reversed notably in October, increasing interest rate volatility and negatively impacting agency RMBS valuations.
John Anzalone: We believe IVR is well-positioned to navigate current mortgage market volatility, given our moderate leverage and robust liquidity, as well as our increased allocation to agency CMBS.
John Anzalone: We continue to selectively capitalize on historically attractive HCRMVS spreads and believe the sector is poised to perform well as the currently volatile election cycle passes.
John Anzalone: Our liquidity position provides substantial cushion for further potential market stress while also providing capital to deploy into our target assets as the investment environment improves.
John Anzalone: In addition, we believe further easing of monetary policy will lead to a steeper yield curve and decline in interest rate volatility, both of which provide a supportive backdrop for agency mortgages as they improve demand from commercial banks, overseas investors, money managers, and REITs.
John Anzalone: Thank you for your continued support for Invesco Mortgage Capital, and now we will open the line for Q&A.
Speaker Change: We will now begin the question and answer session. If you would like to ask a question, please press star 1. You will be prompted to record your name. To withdraw your question, you may press star 2. Again, press star 1 to ask a question. And one moment please for our first question.
Speaker Change: Looks like our first question comes from Jason Weaver with Jones Trading. You may ask your question.
Jason Weaver: Hi, good morning. Thanks for taking my question. I want to bridge to your comments about the addition of the agency CMBS. I appreciate the fact that that might dampen book value volatility, but does that change your approach to how you set leverage targets there, i.e., could you support higher leverage going forward?
Jason Weaver: Hey Jason, it's Brian. Yeah, thanks for the question.
Brian Norris: Yeah, I think, you know, to the extent that our exposure to rate vol declines...
Jason Weaver: that that would allow us to to increase
Jason Weaver: I'll point out also, this is John, the agency CMBS has basically the same borrowing
John Anzalone: costs and haircuts as agency mortgages. So that doesn't impact leverage from that perspective either.
Speaker Change: got it thank you that's helpful and then I was curious about any sort of perspective change in positioning quarter to date noting that you've raised quite a bit on your your ATN in the third quarter
Speaker Change: Yeah, quarter to date, you know,
Speaker Change: nothing too significant changes wise you know I think like I said you know October was pretty volatile and we came into it with a strong liquidity position and and you know moderate leverage and so you know our ability to kind of withstand that volatility allowed us to
Speaker Change: did not have to make significant changes since quarter ending.
Speaker Change: Okay, that's helpful. Thank you.
Speaker Change: Thank you. Again, if you'd like to ask a question, press star 1. Our next question comes from Trevor Cranston with Citizens JMP. You may ask your question.
Trevor Cranston: Great. Thanks.
Trevor Cranston: You guys have historically mostly used swaps for hedging purposes.
Trevor Cranston: I was just curious if you guys have any kind of general thoughts about, you know, swaps versus treasuries, you know, why swap spreads have become so negative and if there's any sort of change in your thinking in terms of using either as hedge instruments going forward. Thanks.
Brian Norris: Hey Trevor, it's Brian.
Brian Norris: Yeah, we certainly started in the third quarter to using Treasury futures more prominently.
Brian Norris: You know, you're right. I mean, swap spreads have been moving tighter for quite a while now. And I think, you know, it's, you know, the move from LIBOR to SOFR kind of removed the credit component of swap spreads.
Brian Norris: And it's mostly more just about treasury supply at this point. And, you know, the expectation is that treasury supply has been robust.
Brian Norris: that's tightening that we've seen could be relatively persistent. And so, you know, our idea is to, you know, increase our exposure, our hedge book in treasury futures that will help mitigate our exposure to swap spreads.
Speaker Change: Okay, got it. That's helpful. Thank you.
Speaker Change: Thank you. Our next question comes from Jason Stewart with J&A. Your line is open. You may ask your question.
Jason Stewart: Hi, thanks. Good morning. Just a quick clarification on the down 5.8 through 11.5. Is that including a dividend accrual?
Jason Stewart: Correct. Yes, yeah, that includes...
Speaker Change: I'm sorry, well it excludes the impact of the dividend.
Jason Stewart: Exclude Forgiveness. Okay.
Speaker Change: Yeah and then you know obviously some big moves this morning with TENS sort of approaching 450 it's just wondering what your macro take was on on where you think TENS as a benchmark for mortgages are headed and in terms of the you know the news we got overnight and maybe how that coincides with your view of rate vol
Speaker Change: Yeah, certainly pretty fresh, pretty fresh moves so far this morning. You know, I think...
Jason Stewart: You know the move in trade rates is
Jason Stewart: was largely expected based on, you know, the outcome of the election. And so that's not a surprise from that perspective.
Speaker Change: I think actually implied vol has come down, so that's been a positive for agency mortgages, at least here initially. I haven't looked in the last 30 minutes or so, so clearly there have been, on the day after the election, some pretty big swings in markets.
Speaker Change: historically but you know I do think that you know
Speaker Change: It's a question of, you know, implied volatility versus realized volatility. I think, you know, like I said, I think implied has come down now that we're kind of past this event, so that's a positive. You know, as far as, you know, where
Jason Stewart: Treasury yields kind of end up you know that's that's a
Jason Stewart: Tough question. You know, I think, you know, the expectation is kind of in that, you know, four and a half to four and three quarters range here in the near term. So we could continue to see some pressure higher, but, you know, the steeper curve and lower implied vol should both be relatively positive, particularly for higher coupon agency markets.
Speaker Change: Thank you very much.
Speaker Change: Yeah, okay, that's helpful, Culler. And then, on the short end of the curve, I mean, the forwards have taken out, you know, about one ray cut.
Speaker Change: so far. Is the House view, or your view, and sort of the way you construct the portfolio, you know, take forward at their word, or do you feel like, you know, when you look at underlying inflation trends, that the Fed might be...
Speaker Change: you know, offsides on some of these moves and we'll see more forwards come out. And I guess net-net to that is, you know, how important is 350 versus a 4% fed funds rate if the curve remains steep to the strategy and the structure of the portfolio?
Speaker Change: Yeah, like, you know, I think...
Speaker Change: To your point, the overall level may be less important as opposed to the steepness of the curve and what it means for volatility going forward. Clearly, we prefer a steeper curve and lower fall.
Speaker Change: Yeah, our house view has been in that five to six cut range between now and the end of 2025. So, you know, I think based on on last night, again, I think that probably moves to the lower end of that range.
Speaker Change: But, you know, I think, you know, clearly there's been a lot of talk about tariffs and tax cuts and so we'll have to just kind of see how that plays out here over the near term.
Speaker Change: before we kind of, you know, settle in on a specific number.
Speaker Change: Okay, thanks for the call, Ernst.
Speaker Change: Thank you. And this question comes from Eric Hagen with BTIG. Your line is open. You may ask your question.
Eric Hagen: Hey thanks, good morning. Maybe a couple follow-ups here. I mean, does retiring the preferred stock change the way that you think about your overall debt-to-equity leverage, and does the range for your leverage that you might explore change because of that at different spread levels?
Speaker Change: Yeah, you know, I think, you know...
Speaker Change: Our overall debt to the common, it doesn't change our view on that, but you know, the total debt to equity will move higher as the capital structure kind of normalizes.
Speaker Change: Okay, is there a target range for your leverage that you envision running with over the near term?
Speaker Change: Yeah, that's a common, you know, we've been pretty comfortable around that nine area, you know, I think, you know, we'll, we'll continue to kind of monitor how the market evolves here over the near term, but, you know, I think
Speaker Change: You know, nine has generally been a pretty kind of conservative slash moderate comfortable level where it gives us a lot of liquidity.
Speaker Change: And, you know, it allows us to maybe take that up a notch higher if we see that ball come down.
Speaker Change: Brian Norris, John Anzalone, John Anzalone, John Anzalone, Brian Norris, John Anzalone,
Speaker Change: As far as duration goes, you know, we...
Speaker Change: intend to keep that pretty close to zero. You know mortgages have been trading pretty long versus rates over well really since the curve has been inverted and so you know what that means is you know they tend to outperform us as rates rally and underperform us as rates sell off you know and I think you know at least in the near term we don't expect that to change.
Speaker Change: too dramatically, but it, you know, like I said, it is dependent upon, you know, where implied volatility kind of moves from here. So sorry, I'm trying to remember what the first question was.
Speaker Change: No, I think you got it. I mean it was just, you know, gauging the sensitivity to spreads in a rally or a sell-off.
Speaker Change: Thanks for the comments. I appreciate it. Oh, right. Yep, sure.
Speaker Change: Thank you again. If you'd like to ask a question just press star 1. Our next question comes from Doug Harder with UBS. You may ask your question. Your line is open.
Doug Harder: Thanks. I'm wondering if you could just touch on how you're thinking about the dividend and, you know, especially kind of in light of, you know, kind of the more challenging start to 4Q.
Speaker Change: Yeah, hey Doug, it's John. Yeah, so, you know, as always, the, you know, our board recommends a dividend or determines a dividend based on recommendations. So, you know, that said,
Speaker Change: You know what we're generally looking at is, you know, where available ROEs on our target assets are. I mean, that's the biggest driver of
Speaker Change: where we set the dividend policy, so, you know, we'll kind of see where that goes.
Speaker Change: in the month and a half until we have to make that decision. So a lot can happen between now and then. And then we balance that with, do you want to stay competitive within the space in line with investor expectations?
Speaker Change: for that though.
Speaker Change: Understood. I get that the markets are moving around a fair bit, but appreciate that answer, John.
Speaker Change: Thank you for watching!
Speaker Change: Thank you and at this time I'm showing no further questions.
Speaker Change: Thank you. That does conclude today's conference. We thank you for your participation. At this time, you may disconnect your lines.