Invesco Mortgage Capital Inc. (IVR) Q1 2018 Earnings Report, Transcript and Summary

Good morning ladies and gentlemen. Welcome to the Invesco Mortgage Capital Incorporated, First Quarter 2018 Investor Conference Call. All participants will be in a listen-only mode until the question-and-answer session. [Operator Instructions] As a reminder, this call is being recorded. Now I would like to turn the call over to Mr. Tony Semak, Investor Relations. Mr. Semak you may begin.

Thank you Amber, and good morning everyone. Again, we really want to welcome you to the Invesco Mortgage Capital first quarter 2018 earnings call. I am Tony Semak with Investor Relations, and our management team and I are very delighted as always that you’ve joined us as we look forward to sharing with you our prepared remarks during the next several minutes before we conclude with our customary question-and-answer session. Joining me today are John Anzalone, our Chief Executive Officer; Kevin Collins, our President; Lee Phegley, our Chief Financial Officer; and Dave Lyle, our Chief Operating Officer. Before we begin, I’ll provide the customary forward-looking statements disclosure and then we’ll proceed to management’s remarks. Comments made in the associated conference call may include statements and information that constitute forward-looking statements within the meaning of the U.S. Securities Laws as defined in the Private Securities Litigation Reform Act of 1995 and such statements are intended to be covered by the Safe Harbor provided by the same. Forward-looking statements include our views on the risk positioning of our portfolio, domestic and global market conditions, including the residential and commercial real estate market, the market for our target assets, our financial performance, including our core earnings, economic return, comprehensive income and changes in our book value, our ability to continue performance trends, the stability of portfolio yields, interest rates, credit spreads, prepayment trends, financing sources, cost of funds, our leverage and equity allocation. In addition, words such as believes, expects, anticipates, intends, plans, estimates, projects, forecasts and future or conditional verbs such as will, may, could, should and would necessarily depends on future events are intended to identify forward-looking statements. Forward-looking statements are not guarantees and they involve risks, uncertainties and assumptions. There can be no assurance that actual results will not differ materially from our expectations. We caution investors not to rely unduly on any forward-looking statements and urge you to carefully consider the risks identified under the captions Risk Factors, Forward-Looking Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K and Quarterly Reports on Form 10-Q, which are available on the Securities and Exchange Commission’s website at www.sec.gov. All written or oral forward-looking statements that we make or that are attributable to us are expressly qualified by this cautionary notice. We expressly disclaim any obligation to update the information in any public disclosure if any forward-looking statement later turns out to be inaccurate. To view the slide presentation today you can access our website at www.invescomortgagecapital.com and click on the Q1, 2018 earnings presentation link, which you can find on the investor relations tab at the top of our home page. There you may also select either the presentation or the webcast options for both the presentation slides and the portfolio and the audio. Again, we want to welcome you and thank you so much for joining us today. We really appreciate you being part of call. And we’ll now hear from our Chief Executive Officer, John Anzalone. John.

Good morning, and welcome to IVRs first quarter earnings call. Joining me to help with Q&A following my prepared remarks will be Lee Phegley, our CFO; Kevin Collins, our President; and Dave Lyle, our COO. I’ll start on slide three with an overview of our first quarter results. Our core earnings were $0.45 per share, which is down from $0.47 in the prior quarter, due primarily to higher funding costs. However, we are pleased that we once again comfortably covered our divided our $0.42. While core earnings remain strong, continued increases in funding costs could potentially pressure core earnings going forward. On a positive side, higher rates and favorable seasonal factors should work to lower our prepayments fees, which would support the core run rate. Book value ended the quarter at $17.16 which is a 6.5% decrease into March 31. However since the majority of the move occurred in the quarter, book value is only down about 1.5% since we announced the level during our last earnings call in the beginning of February. The decrease in book value is due to a combination of widening spreads on agency mortgages, along with the impact of higher rates. Away from agencies, credit spreads performed comparatively well in relation to other fixed income risk assets amidst the state of weakness during the quarter. Seasoned credit assets representative of our holdings are outperforming more recent vintages as expected to continue to exhibit a strengthening credit profile as they roll down the curve. While this is a challenging quarter for book value, the silver lining is that we have seen the reinvestment outlook improve with accretive opportunities available in agency mortgages and in pockets of CMBS. For example we are seeing hedged ROEs on 15 year fixed rate agencies at 11% and 30 year fixed rate agency at 16%, which are levels that we haven’t seen for quite some time. We feel we are positioned well to capture attractive opportunities as they emerge. Slide four breaks out the components of the change in book value. As you can see from the bar chart, the main drivers were the decrease in value and our agency mortgage portfolio, which more than offset the gains in our hedge book. The empirical duration of the portfolio has been running at right around 1.5 years and we intend to keep our empirical duration in a fairly tight range given the likelihood that rate volatility persists. The graph on the lower right of the slide shows the volatility of our book value on a trailing three year basis. As you can see despite this quarter’s negative print we have continued to reduce the volatility in our book value. As you may have read in our 8-K earlier this week, Jason Marshall our CIO is absent on medical leave and as such I’ll cover the portfolio review section of the presentation. Slide six, highlights our diversified portfolio. Our equity allocation remains balanced with 44% in agencies and 56% in credit. This is important because our credit book exhibits favorable duration and convexity characteristics. Credit fundamentals are strong across the board, which I’ll highlight a bit a litter. I’ll go through each of the sectors over the next few slides starting with agencies on slide seven. Our agency portfolio is well diversified with the mix consisting of 62% specified for a 30 year collateral, 21%, 15 year paper and 50% Hybrid ARM. The specified pool 30 helped mitigate prepayment risk, while the 15’s and Hybrid’s are naturally shorter in duration. Prepayments fees had been well contained as seasonal factors have been largely offset by the impact of higher rates. As I mentioned earlier, our expectations are for prepayments to continue to be benign over the coming quarters as seasonal factors turn to favor slower speeds. One other factor that has worked in favor of agencies has been relatively favorable financing costs as agency REPO rates have more closely tracked the OIS rate rather than LIBOR. Given the strongly accretive ROEs available in the sector, we’ve been active in putting money to work in agencies. Moving on to commercial credit on slide eight, our CMBS portfolio consists of what is for the most part a combination of well seasoned single-A /AAA bonds and AA/AAA bonds that are financed at the home loan bank. Fundamentals have been strong as favorable trends and property prices have provided support for this sector. Despite weakness in spread levels across much of the fixed income universe, spreads on CMBS paper have held in extremely well, modestly tightening during the quarter. Slide nine highlights the credit quality of our commercial portfolio. The chart on the left shows the average effect of LTV in our CMBS and CRE portfolios where they have average ratios of 35% and 68% respectively. The chart on the right highlights the season nature of our CMBS book and I point out that our single-A / BBB bonds are largely from 2014 or earlier. Our commercial loan portfolio continues to runoff with a balance of $212 million remaining and a weighted average maturity of about 1 year. Slide 10 covers our residential credit portfolio. This portfolio is also well diversified with 42% in GSE CRT paper, 41% in legacy bonds or legacy Re-REMIC and 15% in Post-2009 Prime paper. Fundamentals are also strong here as economic strength and healthy consumers are more than offsetting the impact of higher mortgage rates. As you can see from the chart at the boom of the slide, durations are very low across the portfolio. Spreads here have also been very well supported as fundamentals – that positive fundamentals and negative net supply have led to spread tightening during the first quarter. As spreads have tightened we have seen less reinvestment opportunities of late and residential credit instead favoring agencies and CMBS. Slide 11 covers the credit quality of our residential portfolio. As you can see from the chart on the left – as you can see from the charts on the slide, fundamentals remain strong. The dollar price in the book is largely above 90 and high price bonds typically exhibit less price and spread volatility affording them favorable financing terms. Our legacy positions consist of Prime and Alt-A paper, while our CRT positions are concentrated in earlier vintages. I’ll end on slide 12 in financing. The only real change we saw this quarter was an increase in financing cost consistent with the increase in short term rates. As I talked about earlier, agency REPO rates which are not exclusively Index to LIBOR lagged the sharp increase in LIBOR. This provided us with a modest benefit related to our sharp hedges which are all Index to LIBOR. One of the things I’ll point out is that we paid off our exchangeable note in March out of available cash. So that ends my prepared remarks and I’ll open the call up for Q&A.

Thank you.

Amber, are you going to provide instructions for queuing up for Q&A?

[Operator Instructions]. Our first question will be coming from Douglas Harter of Credit Suisse. Your line is open.

Thanks. Can you talk about – you mentioned John about your payups. Can you talk about kind of how those performed in the rising rate and you know kind of I guess how much more kind of payup you have on the specified pools and you know whether there is risk to that if rates go further?

Yeah, I mean we did – you know obviously payups are going to be correlated with rates in some respect. You know most of the pools that we have purchased recently you know have been lower payup type bonds under more current coupon and so we haven’t paid up as much. We’re not buying very high payup premium bonds, so we’ve seen a little bit of decrease there, but not significant. I mean I think we saw in spread widening was more just general mortgage spread widening. As prepaids flow, I mean our book is generally speaking prepaids slower than the market so I would assume that as speeds slow, you know our portfolio which is really consistent of either newer production, lower coupon bonds or very, very well seasoned specified pool, higher coupon bonds, I would expect those to slow equally if not more. I mean we may get a little pressure on payups, but you know the slowing speed is a big benefit.

Got it. And then a few other mortgage REITS have mentioned that they have kind of recently been looking at the kind of new production jumbos again or have purchased retain bonds there. Is that something you’re looking at sort of getting back into that and how do you view that opportunity today?

Yeah Dave, are you on?

Yeah, I’m here. You know that is the opportunity in Jumbo’s, especially as supply picks up. Here in kind of recent months it’s something that we are always keeping tabs on and kind of engaging the economics of the trade there, so you know I think the answer to the question is yes. You know with potentially more supply comes potentially better economics and that is something – you know that’s one of the many opportunities that we could potentially get more active in down the road.

Got it, thanks.

Sure.

The next question will be from Eric Hagen with KBW. Your line is open.

Thanks gentlemen, good morning. Please give my best to Jason. My first question is on leverage. It just looks like leverage in the credit segment has risen a bit recently. Can you just provide some color on I guess how you think about leverage in that segment going forward, especially given how tight credit spreads are. Thanks.

Yeah Eric, thanks. Yeah, I would say that the tick-up in leverage really is a function of lower dollar prices on our bonds and in general sense. So we just have less you know assets or less – worth a little bit less and so obviously your financing is a mark-to-market so your leverage appears higher as rates increase. I mean that’s largely what it is. So really I think you know, if there is any difference between where it is on versus CMBS or agency, that’s really just a matter of the mix of you know where we find the best terms. So it’s not really any real decision to like lever the credit anymore or anything like that. I think overall like you know our leverage, we didn’t really move to make leverage higher. This is simply a matter of rates moving up.

Yeah, yeah, no that makes sense, thanks. And then just a question on CPR’s, just kind of a technical question. I guess the CPR that you reported for the non-agency MBS, is that a collateral CPR or is that the runoff for your actual bond?

Yeah, on non-agent – this is Dave. On non-agencies that is a collateral CPR. So it accounts for all voluntary prepayments, as well as the recovery portion of defaults.

Great. Maybe I can press you just a bit on the prepaids for the legacy Alt-A segment and how you see that trending going forward.

You know it’s a very seasoned book. It’s not nearly – the CRP on Alt-A’s is not nearly as sensitive to prevailing mortgage rates as newer production obviously and especially performing production. So we don’t expect dramatic changes. There is some sensitivity there obviously, so it will oscillate a bit and you will continue to have – you know faster prepaids are good on legacies obviously given the discounted basis. I think we’ll continue to see some tailwinds from you know further equity recovery in terms of borrower equity and the flexibility that gives borrowers to refi. So that should continue to support prepaids to an extent and you know offset some of the slowing prepaid effect of higher rates.

Yeah, I guess the obvious follow-up question, my first one about CPR is just what is your actual bond, your bond CPR, I mean just given where you are in the capital structure and how we should think about the runoff in that portfolio going forward. Thanks.

Yeah, you know I don’t want to mis-quote a specific number. I don’t have it in front of me. We disclosed you know a certain level of CPR detail in our filings, so I would check there, but overall in the book it tends to be quite a variety of assets that go into that number that we disclosed, but that number tends to be very low double digits.

Yeah, great, thank you. That’s helpful.

Sure, yes.

[Operator Instructions] And your next question will be from Trevor Cranston with JMP Securities. Your line is open.

Hi, thanks. A couple of questions on the swap portfolio. I guess first I didn’t see the notion anywhere, so if you can give that, that would be helpful. And then second on the receive side, here in the press release you showed the received rate for the first quarter at 168 which is you know lower than where the three month LIBOR was throughout the quarter, so can you say how much of the swap portfolio is index to one month versus three month LIBOR. That will be helpful somewhat thanks.

Yeah, I don’t have the exact notion amount in front of me, but that will be in our filing, so I’ll differ for there a bit. As far as what we’re receiving, its approximately half and half, three month and one month LIBOR.

Okay, that’s helps. On the notional would you say you know was there any meaningful additions since the…

Yeah, I mean we added, we did add hedges – yeah, we added about $650 million of hedges during the quarter and it’s up to $9.2 billion and we added another $800 million start that came onboard of support starting swaps.

Support starting, okay.

Right, so yeah, so it did increase over the quarter, right.

Okay, perfect. And then second question here on book value with you know rates moderately higher again this quarter, can you give an update on where you guys are seeing book currently?

Yeah, it’s basically unchanged. It’s basically – so we’ve added swaps. Our interest rate sensitivity is leveled off a bit and agencies have settled down a bit also. You know spreads have been pretty well behaved, so we’ve seen book value remain pretty stable.

Got it. Okay, thank you.

Yep.

Thank you. Speakers, at this point we have no further questions. I’d like to hand the meeting back to you.

Well, thanks Amber. We appreciate your help with the call today and we want to thank everyone who has joined us and as always, if there might have been a question that comes to mind afterwards, we’ll also like to help and you can reach out to us. So we really appreciate as always. Have a great day! Thanks everyone.

Thank you, speakers. And this does conclude today’s conference call. Thank you all for participating. You may now disconnect.