Earnings Labs

Invesco Mortgage Capital Inc. (IVR)

Q4 2018 Earnings Call· Thu, Feb 21, 2019

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Transcript

Operator

Operator

Welcome to the Invesco Mortgage Capital Inc. Fourth Quarter 2018 Investor Conference Call. All participants will be in listen-only mode until the question-and-answer session. [Operator Instructions] Now I would like to turn your call over to Brandon Burke, Investor Relations. Mr. Burke you may begin the call.

Brandon Burke

Analyst

Thank you, and welcome to the Invesco Mortgage Capital fourth quarter 2018 earnings call. The management team and I are delighted you've joined us, as we look forward to sharing with you our prepared remarks during the next several minutes before concluding with the question-and-answer session. Joining me today are John Anzalone, our Chief Executive Officer; Kevin Collins, our President; Lee Phegley, our Chief Financial Officer; Dave Lyle, our Chief Operating Officer; and Brian Norris, our Chief Investment Officer. Before we begin, I would like to direct your attention to slide two of our earnings presentation, which discusses forward-looking statements in detail. Statements made in this conference call regarding Invesco Mortgage Capital that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. 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 SEC Web site 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 may access our Web site at invescomortgagecapital.com and click on the Q4, 2018 earnings presentation link, you can find on the Investor Relations tab at the top of our home page. There you may also select the presentation or the webcast options for both the presentation slides and the audio. Again, welcome and thank you for joining us today. And I will turn the call over to our CEO, John Anzalone. John?

John Anzalone

Analyst

Good morning, I would like to welcome everyone to Invesco Mortgage Capital's fourth quarter earnings call. I'll provide a recap of our results and an update on our outlook before turning over the call to Brian Norris, who will go through the portfolio in a little more detail, as well as providing some color on the successful deployment of the proceeds from our recent capital raise. The volatility that the financial markets experienced during the fourth quarter impacted nearly all risk assets, and our mortgage investments were no exception. We saw wider spreads across our entire portfolio, and agency mortgages had a particularly rough quarter, sharply underperforming treasuries. This led to a decline in our book value of 9.3% during the fourth quarter. Importantly, this price action was not due to any deterioration in the fundamental credit quality of the assets underlying our investments or reflected turmoil across markets caused by a host of macro factors, uncertainties surrounding fed policy, trade policy, the government shutdown, Brexit, amongst others. As the concern over these factors began to recede we saw a meaningful recovery in recent weeks, and our book value has since recovered about half of the fourth quarter decline. On the positive side, we increased our core earnings for the quarter by $0.05 to $0.46 per share, easily covering our $0.42 dividend. This reflects the portfolio repositioning we executed during the second-half of 2018, moving out of lower yielding 15-year and hybrid arm agency mortgages, and buying current coupon agency mortgages and agency CMBS with more attractive ROEs. The portfolio rotation and our active interest rate hedging strategy allowed our net interest margin to increase by approximately 13 basis points despite an increase in funding costs. Our outlook for the quarter -- for the portfolio is quite positive, as credit…

Brian Norris

Analyst

Thanks, John. I'll start on slide six, which provides a breakdown of the broad sector allocations in our portfolio, both on an equity and total asset basis. As indicated by the pie chart in the upper-left-hand corner, our equity allocation to agencies and credit remains well balanced, even as our allocation within the agency buckets shifts modestly into agency CMBS, as we have increased that balance to $1 billion of total assets. ROEs on both agency RMBS and agency CMBS remained attractive during the fourth quarter, and we were able to continue the portfolio rotation we started in the third quarter levels accretive to earnings. The benefits of the portfolio rotation can be seen in our portfolio yield and effective net interest margin, which have both improved despite our higher borrowing costs, improving the long-term earnings power of the company. Overall, leverage increased quarter-over-quarter to 6.7 times from 6.4 as investment spread widening led to an increase in the amount of assets pledged for repo financing. Moving on to slide seven, the repositioning within our agency RMBS portfolio during the second-half of 2018 was mostly out-of-seasoned shorter duration 15-year and hybrid collateral, and then to newer production 30-year specified pools. This is reflected in the pie chart in the upper-left-hand corner of the slide as 30-year specified pools now comprise close to 90% of our agency RMBS portfolio. We continue to favor loan balance, LTV, and geographic-specific stories to help mitigate the impact of prepayments. Valuations remain attractive given spread widening in 2018, as hedged ROEs are approximately 14%. With monetary policy on hold for now, we expect agency RMBS to remain an attractive asset class, as volatility remains low and further fed hikes are priced out of the forward curve. Turning to slide eight, for a few brief comments…

Operator

Operator

[Operator Instructions] And our first question comes from Doug Harter of Credit Suisse. Your line is open.

Doug Harter

Analyst

Thanks. Can you just talk about where you might be in terms of portfolio rotation, just thinking about whether there's more room for asset yield improvement or has most of that kind of been reflected in the 4Q results?

Brian Norris

Analyst

Yes, I think -- this is Brian, and thanks, Doug. We've mostly made it through a lot of the rotation as rates have fallen or fell in the fourth quarter that kind of produces fewer opportunities to rotate out of lower book yielding assets and as you see in the slides there that our 15-year and the hybrid arm exposures are pretty low at this point, so we've mostly worked through the rotation at this point.

Doug Harter

Analyst

Great. And then just thinking about the dividend given the kind of the strong core earnings you had for the quarter, plus your commentary that this capital was accretively deployed. Can you just tell us how you're thinking about the dividend?

John Anzalone

Analyst

Right. Yes, this is John. Yes, so I mean first of all, our Board sets a dividend so I'll just put that out there first. But I think where we're pretty positively -- we're thinking pretty positively about the core earnings trajectory we have at this point. There's some time between now and the next declaration, so as long as trends continue we'd be thinking favorably towards that.

Doug Harter

Analyst

Great. Thank you, John.

John Anzalone

Analyst

Yes.

Operator

Operator

Thank you. Our next question comes from Eric Hagan of KBW. Your line is open.

Eric Hagen

Analyst

Oh, great. Thanks, good morning. Thanks for the comments at the end about the deployment of the capital raised, maybe you can just provide a little color on where leverage stands as a result of having made that deployment. I guess I can sort of reverse engineer based on the comments, but hopefully you can just kind of tell us. Thanks.

Brian Norris

Analyst

Sure, Eric. Thanks. It's Brian again. As we've kind of noted in the past, our leverage number is mostly a function of our asset mix. And so as we transition more into agency RBMS and CMBS at this point, our leverage will tend to tick a little bit higher. During the fourth quarter, leverage did go higher due to spread widening. And we've seen that reverse a little bit, certainly as spreads have tightened the leverage number had recovered a little bit and fallen. But given the composition of our equity raise, which was predominantly in agency securities, we would anticipate leverage to tick modestly higher.

Eric Hagen

Analyst

Modestly higher, great, thanks. And then I know you guys have maybe seldom hedged the volatility risk in the agency portfolio by buying things like swaptions. But as the agency portfolio grows a bit more, and I know that in your prepared remarks you said that you expect volatility to be low, but what would, besides just an expectation for higher volatility, would you guys consider hedging the volatility in your portfolio going forward, if you expect volatility to actually increase? Thanks.

John Anzalone

Analyst

Sure. Yes, swaptions is certainly something that we can use, and we consider it quite often. But as you noted, it's not something that we typically have been doing. So, what we prefer to do is, on the asset side, is to select specified pools with favorable convexity characteristics or prepayment characteristics to help mitigate the impact of volatility on our assets.

Eric Hagen

Analyst

Okay, great. And then on the CRT side, can you just provide maybe a little color. Are you buying the first loss piece or do they have some attachment point that's above that? And are they high LTV or low LTV loans? Thanks.

Dave Lyle

Analyst

Yes, hey, this is Dave Lyle. Our portfolio, we don't have any first or -- we don't have any B classes in our CRT portfolio. It's all essentially the lowest M class, and what Fannie and Freddie have done and what they've been issuing over time has changed. But it's in -- and if you go back a few years it depends on which shelf you're looking at. But it's mostly -- or it's really all M2s and M3s, so sort of the mezzanine risk with significant amount of credit enhancement that we've seen grow over time as the structures have delevered. And as to LTVs, we own both. We feel that it's a pretty balanced risk profile between standard LTV and high LTV exposure with the additional credit enhancement that's added on the high LTV deals.

Eric Hagen

Analyst

Great. And then on the ratings upgrade, I mean do they typically -- are those typically done after a certain seasoning point or when -- how should we think about the upgrades on those bonds going forward as far as when we can maybe expect to see individual issues get upgraded, potentially get upgraded?

Dave Lyle

Analyst

Frankly, it's a little unpredictable. Each of the rating agencies kind of has their own approach to how often they review the ratings. We can look at -- we get monthly reports on delinquencies and enhancement levels, and you can kind of look at that information and see at which points they have kind of been leading indicators of coming upgrades on certain bonds, so you can kind of get an idea of which bonds are sort of next in line, but you don't know necessarily when it's going to happen. But we do -- if we do anticipate -- a lot of the upgrades are behind us given the seasoning on the collateral, but I think there's still a fair amount of room to run because the trends have led to the upgrades continue in terms of delevering, rolling down the curve, continued strong loan performance.

Eric Hagen

Analyst

That's really helpful color, thank you.

Dave Lyle

Analyst

Sure.

Operator

Operator

Our next question comes from Trevor Cranston of JMP Securities. Your line is open.

Trevor Cranston

Analyst

Hi, thanks. Given your comments about the portfolio rotation largely being completed out of the lower yielding assets, and the attractiveness of new investment opportunities you're seeing pretty much across all the buckets of the portfolio. Can you comment on your potential appetite for potentially another capital raise given that the first one is complete and new investments sound like they would continue to be accretive, if you could deploy? Thanks.

John Anzalone

Analyst

This is John. I think we approach it -- we've always approached both issuing equity and buying back equity frankly to do what's best for shareholders. So, in this case, it was -- we felt like the accretive nature of what we were buying was very good. So, if those conditions persist then we would likely make the same decision if we see the same sort of opportunity. But, obviously we just got done with this one, so we're going to take a little bit of a breather, but certainly I think if you listen to all the different -- think about all the different sectors, I mean we are seeing pretty good opportunities across. And we're pretty positive on the outlook for most of the sectors just given the volatility and this environment is pretty good for structured securities.

Trevor Cranston

Analyst

Got it. Okay, that's helpful. And then on the resi credit side, it says that you guys purchased $60 million or so in the fourth quarter of post-2009. Can you elaborate a little on that if that's like new issue jumbo deals or -- and maybe add some color around exactly what opportunities you're seeing in the resi credit market currently? Thanks.

Dave Lyle

Analyst

Yes, that's correct. This is Dave again. The bonds that we purchased are new issue prime jumbo AAAs, so the senior tranche there, the spreads got pretty wide there in the fourth quarter as they did on many of our target assets. And the repo terms available for leverage on those investments have continued to improve. So, we were able to add those at pretty materially accretive ROEs I think market has firmed here a little bit in the first quarter. That particular investment is a little more border line because we think about the risk that we take with CRT and adding that sort of profile to our portfolio is a nice complement to our agency exposure. CRT is one month LIBOR floater so it's very easy to hedge, so it's bit more of a good credit asset, whereas Prime Jumbo seniors are much more agency MBS light. There is a yield pick there because they are bit less liquid and there's small credit -- probably materially less liquid than agencies obviously and there is theoretically a credit components -- and we have seen very, very, very clean credit profiles in these bonds. So, the point being they don't add a lot of diversification risk to the portfolio so it's going to be pretty healthy ROEs on Prime Jumbo to continue adding. So we are probably if we continue adding. So if we continue to see the market tighten and risk continue to do well, I wouldn't expect us to add a significant amount of Prime Jumbo, but resi credit overall that's our CRT and Prime Jumbo are the most accretive opportunities. There have been talks obviously of non-QM and RPL securitizations. We do like those deals from a fundamental perspective. We manage those assets in unlevered portfolio away from the REIT, so we like the asset classes. But given the where the spreads are relative to funding terms, they only lever kind of into the high single digits. So not very compelling for the REIT compared to other opportunities that we have.

Trevor Cranston

Analyst

Got it. Okay. And then, one last question. Just a detail on the hedges you guys mentioned that added subsequent to the capital raise, can you just give us the approximate duration of the swaps that you put on? Thanks.

Dave Lyle

Analyst

Yes, our swap book kind of ranges from one to 10 years, and I believe the hedges that we added in the fourth quarter reflected kind of a mixture of shorter duration -- shorter swaps like in the two to three year range mixed with some longer five to seven year swaps.

Trevor Cranston

Analyst

Okay, that helps. Thank you.

Operator

Operator

Thank you. And we have no other questions from the phone line.

Brandon Burke

Analyst

Okay. Well, I would like to thank everybody for joining us and we'll talk to you next time. Thanks.

Operator

Operator

Thank you for your participation in today's conference. You may now disconnect at this time. Have a wonderful day.