Q4 2023 Invesco Mortgage Capital Inc Earnings Call

Participants

Greg Seals; IR Contact Officer; Invesco Mortgage Capital Inc

John Anzalone; CEO; Invesco Mortgage Capital Inc

Brian Norris; Chief Investment Officer; Invesco Mortgage Capital Inc

Trevor Cranston; Analyst; JMP Securities LLC

Jason Weaver; Analyst; Jones Trading

Doug Harter; Analyst; UBS Equities

Eric Hagen; Analyst; BTIG

Presentation

Operator

Welcome to Invesco Mortgage Capital Incorporated's fourth-quarter 2023 investor conference call. (Operator Instructions) As a reminder, this call is being recorded.
Now, I would like to turn the call over to Greg Seals, Investor Relations. Mr. Seals, you may begin the call.

Greg Seals

Thank you, operator.
And to all of you joining us on Invesco Mortgage Capital's 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 at Invesco Mortgage Capital.com. This information 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. Please review the disclosures on slide 2 of the presentation regarding these statements and measures as well as the appendix for the appropriate reconciliations to GAAP.
Finally, Invesco Mortgage Capital is not responsible for and does not edit or guarantee the accuracy of our earnings teleconference transcripts provided by third parties. The only authorized webcasts are located on our website. Again, welcome, and thank you for joining us today, and I'll now turn the call over to John Anzalone.
John?

John Anzalone

Good morning, and welcome to Invesco Mortgage Capital's Fourth Quarter Earnings Call. I will give some brief comments before turning the call over to our Chief Investment Officer, Brian Norris, to discuss the portfolio in more detail. Also joining us on the call are our President, Kevin Collins, and our CFO, Dave Lyle. As we entered the fourth quarter, interest rate volatility accelerated as changes in investor expectations for the supply of U.S. treasuries in the path of monetary policy led to substantial adjustments to both the level of interest rates and the shape of the yield curve. The heightened volatility drove notable underperformance in agency mortgages as industrial reduced exposure to the asset class through this period, we sought to maintain appropriate levels of cash and unencumbered assets, reducing risk by decreasing leverage as volatility increased and market sentiment improved bolstered by incoming data supporting a soft landing narrative and work expectations for a quicker pace of interest rate cuts by the Federal Reserve, we returned to our target range despite the volatility we experienced during the quarter. Our book value per common share ended the quarter at $10, representing an increase of 0.7% from September 30. When combined with our $0.4 common stock dividend This produced an economic return of 4.7% for the quarter. Our debt to equity ratio ended the quarter at 5.7 times, down from 6.4 as at September 30. As of the end of the quarter, nearly all of our $5.1 billion investment portfolio was invested in agency mortgages, and we maintained a sizable balance of unrestricted cash and unencumbered investments totaling $422 million earnings available for distribution for the period, benefiting from attractive interest rate, interest income on our target assets, favorable funding and low-cost pASIC slots. For the quarter, EBDT per common share was $0.95 compared to $1.51 for the third quarter, reflecting declines in interest income on investments and interest rate swaps in connection with the reduction in leverage and adjustments to our swap portfolio over the first six weeks of 2020 for mortgage valuations have been challenged with lower coupons underperforming higher coupons. As of February 16, our book value per common share is down moderately estimated to be between $9.50 and [98] as we enter 2020 for both the FOMC and the federal funds futures market forecast. The next policy move by the FOMC will be a rate cut on the differing expectations in earning the timing and quantity of these cuts. While evolving expectations on the timing of changes in monetary policy may bring challenges in the coming months, we view that as a potential reduction in interest rate volatility, combined with compelling valuations and favorable funding conditions will support an attractive investment environment for agency mortgages in 2024.
I'll stop here. Brian will go through the portfolio.

Brian Norris

Thanks, John, and good morning to everyone listening to the call, and I'll begin on Slide 4, which provides an overview of the interest rates to agency mortgage market. Since the beginning of last year. As shown on the chart in the upper left, U.S. Treasury yields fell sharply across the yield curve in a parallel fashion during the fourth quarter. Yield on maturities from two years to 30 years declined between 65 and 80 basis points. And the disinflationary trend and economic data persistent, while estimates of future treasury funding needs declined by the end of the fourth quarter. Pricing in the Fed funds futures market reflected expectations for a 25 basis point cut in the target rate in the first quarter of 2024 and nearly seven cuts in total by the end of January 2025. Despite further runoff of Federal Reserve's balance sheet during the quarter, the decline in interest rate volatility and expectations for the easing of monetary policy led to an improvement in domestic bank holdings of agency mortgages for the first time in nearly two years.
Slide 5 provides more detail on the agency mortgage market. In the upper left chart, we showed 30-year current coupon performance versus US Treasuries over the course of 2023. Iot in the fourth quarter in gray. Despite notable underperformance, the fourth quarter production coupon agency mortgages, mortgage valuations rebounded into year end and interest rates and interest rate volatility declined. Ultimately, current coupons outperformed treasuries during the quarter with nominal spreads tightening approximately 30 basis points. In addition, specified pool payouts and crude as interest rates fell, as illustrated in the chart on the top right, as shown in the lower right chart. The overall market for TBA securities remain unattractive as more recent issuance with higher loan balances have a worse prepayment profile and the lack of consistent bank demand has negatively impacted technicals.
Slide 6 provides detail on our Agency Mortgage Investments and summarizes changes during the quarter. Our portfolio decreased by 7% quarter over quarter as the sharp increases in interest rate volatility in October warranted a reduction in risk. We net sold approximately $1.7 billion of specified pools in October across our combined holdings to reduce the risk of further declines in book value before adding nearly $1.2 billion of exposure, predominantly in 30-year 6% specified pools in November and December. As interest rate volatility declines. We remain focused in our and more attractively priced higher coupons, which are largely insulated from direct exposure to assets held by commercial banks and on the Federal Reserve's balance sheet in addition, we remain exclusively invested in specified pools, which means we have no exposure to the deterioration in the dollar roll market for TBA securities, we focused our specified pool allocation on prepayment characteristics that are expected to perform well in both premium and discount environments and modestly improved the quality of our specified pool holdings by increasing our allocation to lower loan balance stories. Although we anticipate interest rate volatility to remain moderately elevated in the near term, we believe current valuations on production coupon agency mortgages, largely price in this West represent attractive investment opportunities with current gross ROEs in the mid to high 10s. Our agency CMO allocation is detailed alongside our remaining credit investments.
On slide 7, our allocation to agency interest-only securities remain largely unchanged following $75 million a quarter and a modest decline from $78 million at the end of the third quarter to 70 months, $75 million. This quarter, primarily due to paydowns and a modest decline in the weighted average dollar price. Given the rally in interest rates during the quarter, our credit allocation declined during the quarter to $19 million. As a result of paydowns, our credit investments remain high quality with 68% rated double-A or higher. Although we anticipate limited near-term price appreciation in our credit and agency I/O investments. We believe these assets provide attractive yields for unlevered holdings.
Slide 8 details our funding and hedge book. At quarter end repurchase agreements collateralized by agency RMBS declined by from $5 billion to $4.5 billion. And our net notional pay-fixed interest rate swaps declined from $5 billion to $4.1 billion, both commensurate with our reduction in specified pool holdings during the quarter, we continue to reposition the hedge book, unwinding our remaining received fixed interest rate swaps and a portion of our legacy pay-fixed swaps as the reduction in leverage during October, October warranted a proportionate decline in hedges as we added specified pool exposure back to the portfolio in November and December. We also added new pay-fixed swaps to hedge the additional borrowings. We ended the quarter with a hedge ratio of 91%. These changes resulted in a modest increase in the weighted average coupon on our pay-fixed swaps, which negatively impacted earnings available for distribution positively, we retained much of the benefit of our low-cost pay-fixed swaps with an attractive weighted average coupon on our hedging portfolio of 1.1% and weighted average maturity of 6.6 years. Leverage ended the quarter at 5.55 0.7 times debt to equity, down from 6.4 times at the end of September, given the net sales and specified pools and modest improvement in book value.
Slide 9 provides further detail on our asset yields and funding costs. Interest rates on our repurchase agreements increased modestly from 5.4% to 5.5% at quarter end, largely offset by a similar increase in the receive rate on our interest rate swaps yields on our Agency RMBS portfolio increased approximately 20 basis points to 5.3%, while the pay rate on our interest-rate swaps increased 30 basis points to 1.1%. Overall, our effective interest rate margin remains very attractive at just over 5%, which includes the benefit of our remaining legacy swap portfolio.
To conclude our prepared remarks. The fourth quarter of 2023 began and is another very challenging quarter for Agency RMBS investors as uncertainty regarding the path of monetary policy led to another sharp increase in interest rate volatility. Valuations rebounded. However, this employers and disinflationary trend persisted despite the notable strength in the economy, resulting in our intended for expectations of monetary policy from further tightening potential easing in the first half of 2024. Despite significant tightening of spreads in the asset class in the fourth quarter, we believe Agency RMBS valuations remain attractive for long-term investors in our expectation for the potential reduction in interest rate volatility over the course of 2024 as easing monetary policy likely result in a steeper yield curve, our preference for higher coupon. Such nonaccruals should perform well in that environment. Further, our liquidity position remains robust. As a result, we believe IVR is well positioned to navigate future mortgage mortgage market volatility and selectively capitalize on historically wide Agency RMBS spreads, which provides a supportive backdrop for long-term investors investment.
Thank you for your continued support for Invesco Mortgage Capital and now we will open the line for Q&A.

Question and Answer Session

Operator

Thank you. We will now begin our question-and-answer session. (Operator Instructions) Trevor Cranston, JMP Securities.

Trevor Cranston

Thanks, good morning. A question on the hedging side. It looks like the net swap portfolio declined by more than the MBS portfolio did on the quarter on is can you elaborate a little bit on, you know, if you guys have made any changes to your net duration exposure along any any part of the yield curve given the and shifting outlook for on what the Fed is going to be doing going forward? And just generally how you're how you're approaching hedging across the yield curve right now?

John Anzalone

Yes, good morning. However, as Brian yet, we haven't really made any significant changes to our yield curve exposures. We're positioned slightly for a steeper curve and given our expectations for Fed policy in 2024, the sharp rally that we saw in interest rates during the fourth quarter didn't shorten our mortgage investments. And so you saw the shortening in our in our hedges as well. But really the changes that we made this loan portfolio were pretty consistent across the curve. So there weren't any significant changes and as far as our duration gap goes, we're still just modestly positive, but very slight.

Trevor Cranston

Okay. Got it. I appreciate the comments. Thank you.

Operator

Thank you. Jason Weaver, Jones Trading.

Jason Weaver

Hey, guys. Thanks for taking my question. I have sort of a two-parter here. I've seen over the last three, four quarters. You've been migrating higher in the coupon stack. Obviously, that's in response to the available ROE in the market. But what do you think of the convexity profile here given your remarks on the timing of monetary easing easing? I assume you're still migrating up to quarter to date?

Brian Norris

Yes. Hey, Jason, it's Brian. Good morning. Good to hear from you. Yes, you know, we have moved slightly up in coupon. Obviously, we did buy some sections in the fourth quarter that do have a slightly worse convexity profile. But just given our expectations for interest rate volatility, you know, we don't exactly mine taking a little bit of additional equity risk from that perspective. And given our continued holdings in four to five in ads that are still at decent discounts. We certainly have a fair amount of protection from that perspective as well.

Jason Weaver

I'm on that subject to the new coupon, new high coupons in the sixes are what is the typical type, especially specified pool, those guys aren't.

Brian Norris

Yes, it's pretty consistent with the rest of our portfolio, leaning a little bit heavier in loan balance, but also higher loan balance cuts column 25 to 30 k. And we'll also have a fair amount in the lower pay-up stories like LTV and PICA NGO source book.

Jason Weaver

Got it. All right. That's helpful. And finally, I see cash right now at around $77 million. I know you have some unencumbered as well for enhanced liquidity, but does that imply you're inclined to raise leverage going forward,

Brian Norris

I wouldn't necessarily say we're inclined to raise leverage. We do have the ability to do that. If we if the market volatility declines and we see improvement and valuations Yes, but I wouldn't say we're not certainly inclined to do that in the near term.
Yes, I think we still certainly there's still some uncertainty about the timing of Fed policy and we would expect there continue to be some some rate vol around that until that kind of kind of comes to fruition. So at the moment, I think we're pretty comfortable with where we are, but we do have the ability to increase leverage if if conditions warrant that.

Jason Weaver

All right. Thank you for that color, and congrats, guys.

Brian Norris

Thank you.

Operator

Thank you. Doug Harter, UBS.

Doug Harter

Thanks. Hoping to get your thoughts around the dividend, if you look at it relative to the common book value, it kind of screams higher. But if you look at it relative to total equity on factoring in the preferreds, it seems and kind of more in line just curious as to how you're thinking about the dividend.

John Anzalone

Yes, I'd say Hey, Doug, it's John. Yes, I mean, as always, the dividend is secure, both board. And so you know that you're saying it, but I think given where E. ON has trended lower and the adjustments in the swap book, you have a he supports supports the level of dividend. I'm pretty comfortable at this point on. Certainly we do look at critically if it were in our level of dividend, it is really an outlier versus peers. That's one consideration we think about for a year of acceleration is really where we will be see cash flows and where we see a were forecasting that over there the next several quarters. So from that perspective, we simply assume well supported. So, you know, I think as long as things stay relatively around here, Tom, yes, I don't see any catalysts to institutions, but then again, it's pretty early so on.

Doug Harter

Yes, that's right. Thanks, John. And then around the capital structure, I guess, how are you thinking about now on your kind of plan and to kind of bring the preferred level preferred equity as a percentage down? And then sort of along those lines, how do you think about is do you think about leverage as more leverage to comment or leverage to total equity. And when we look at it both ways in terms of leverage, how we think about it on leverage to common equity is probably the way we think about risks?

John Anzalone

Yes, some more often or we give some of that. I'd comment that we think about it on. And as far as capital structure, we've been on buying back preferreds in the market. It's been a very slow process given just given the amount of activity in those issues out there.
Tom, I think the we have two two preferreds out there. Our Series C is callable at the end of this year. And so we have, as it will have a decision to make come fourth quarter, um, and we're looking we'll be starting and there are starting to look at options around on ITO, whether we call that or not, and you know how we kind of handle handle that coming back coming event. So but we do continue to intend to buy as those back in then when the market is willing where we have lower or medium when market conditions are appropriate, we are also looking to raise money through the ATM, which would also help balance the capital structure. So both those two things we're going to do after a year.

Doug Harter

Great. Appreciate that Thank you.

Operator

(Operator Instructions) Eric Hagen, BTIG.

Eric Hagen

Good morning. How are you doing, say on the specified pools? Can you give a sense for how much pay-ups are right now for the bonds that you're focused on by relative to where those payoffs have been historically?
And do you feel like there's a good way to think about how much relative strength those bonds can show and different interest rate rally and there are the arguments, Brian?

Brian Norris

Yes, you know, I think I'm told, as I mentioned, the payoffs did improve in the fourth quarter, given given what we saw happen in the rates market and those they've come off a little that so far in Q1, we had rates are now up 45 to 50 basis points since year end. So you'd expect some softening in payoffs. And so we've seen that. But yes, our weighted average fab, I think, Vince, what 0.4 points. So yes, they our exposure to those changes is fairly limited. I think the FiberCo and LTV stories and even the geo stories are pretty low payoffs. And so there's not a lot of change that goes on and those that's really kind of driven by the changes in loan balance and that are a little bit higher payoffs. So call it half a point to three-quarters of a point. So although those will change as the interest rate markets kind of adjust around that. But we're still yes, it hasn't changed kind of what we're targeting as far as attractive additions at this point we still think that the TBA market will continue to have no issues and net implied financing will continue to be higher there than it is. And so that's our goal. So to the extent that we are looking to add on?
Yes, at this point, it would certainly be and that's our goal.

Eric Hagen

Do you feel like there's anything that will catalyze dollar roll specialness aside from the Fed showing up Q2, you're making investments security?

Brian Norris

Yes, I think if we were to see a significant return from banks know, we have seen some encouraging signs from them over the last few months in these at least stopped running off their portfolio as significantly as they had had been. But I do think that, yes, banks are really the primary driver of demand for it does generic type securities. And so that, yes, Mark, is it really driven by supply and demand dynamics and until that starts to improve I know it's hard, but envision the dollar roll market improving all that much because quite frankly, the other aspect of that is you know that the convexity profile of the of the deliverables and that is not appearing to get any better on that loan balance continuing to float balances. It continues to increase.

Eric Hagen

Right. Okay. That was helpful.The book value range that you gave quarter-to-date, is that inclusive of the accrued dividend?

Brian Norris

Are you netting out the accrued dividends that nets out the dividend? And that's

Eric Hagen

okay. Thank you, guys, so much.

Brian Norris

Yes, thank you.

Operator

And at this time, we have no further questions.

John Anzalone

Greg, I'll hand it back to you again, very much towards the registration and look forward to speaking to you next quarter.

Operator

Thank you. That concludes today's conference and thank you for participating. You may disconnect time.