Welcome to Invesco Mortgage Capital Inc.'s first quarter 2022 investor conference call. All participants will be in a listen-only mode until the question and answer session. At that time, to ask a question, please press star followed by one on your phone. As a reminder, this call is being recorded. Now I'd like to turn the call over to Jack Bateman in Investor Relations. Mr. Bateman, you may begin.
Thank you, and welcome to the Invesco Mortgage Capital first quarter 2022 earnings call. The management team and I are delighted you've joined us, and we look forward to sharing with you our prepared remarks and conducting a question and answer session. Before turning the call over to our CEO, John Anzalone, I wanted to provide a reminder. Statements made in this conference call and the related presentation may include forward-looking statements which reflect management's expectations about future events and our overall plans and performance. These forward-looking statements are made as of today and are not guarantees. They involve risks, uncertainties and assumptions, and there can be no assurance that actual results will not differ materially from our expectations. For a discussion of these risks and uncertainties, please see the risks described in our most recent annual report on Form 10-K and subsequent filings with the SEC.
Invesco makes no obligation to update any forward-looking statement. We may also discuss non-GAAP financial measures today, during today's call. Reconciliations of these non-GAAP financial measures may be found at the end of our earnings presentation. To view the slide presentation today, you may access our website at invescomortgagecapital.com and click on the Q1 2022 earnings presentation link under Investor Relations. Again, welcome, and thank you for joining us today. I'll now turn the call over to John Anzalone. John?
Good morning and welcome to Invesco Mortgage Capital's fourth quarter earnings call. I'll 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 to participate in the Q&A are our President, Kevin Collins, our CFO, Lee Fegley, and our COO, Dave Lyle. The first quarter was characterized by continuation of the challenging market conditions that we saw in the fourth quarter of 2021 as the Federal Reserve responded to surging inflation by increasing the fed funds rate and signaling potential further policy tightening through a reduction of its balance sheet. The yield curve bear flattened during the quarter as the market priced in more aggressive rate increases by the FOMC.
During April, the yield curve has flattened further and interest rates moved higher as the market responded to inflation prints not seen in decades. Given the increased interest rate volatility, flatter curve and potentially more aggressive balance sheet reduction by the Fed, mortgages significantly underperformed during the quarter, posting their worst performance since the GFC. This underperformance led to a decline in our book value of 28.5% during the quarter as the lower coupons that make up the bulk of the Fed's holdings underperformed the broader market and the payoffs on specified pool collateral fell as mortgage rates rose above 5%. Our book value declined an additional 13% during April as the spread widening in agency mortgages continued. Despite the negative performance, our liquidity position remained strong as we held $665 million of unrestricted cash and unencumbered investments at year-end.
While this environment was very difficult for mortgage valuations, positively, Earnings Available for Distribution remained supported by slowing prepay speeds, attractive dollar rolls and higher yields on new investments and came in at $0.12 per share. Looking ahead, we remain cautious on mortgages in the near term as the market weighs the possibility of more aggressive balance sheet reductions by the Fed. As a result, we are continuing to reduce leverage and rotate to higher coupon mortgages. Longer term, we expect the environment for mortgage valuations to improve as wider spreads on agency mortgages compare favorably to other sectors. Attracting crossover buyers and higher rates will lead to further reductions in prepayment rates and a decline in net supply. I'll stop here and let Brian go through the portfolio.
Thanks, John, and good morning to everyone on the call. I'll begin on slide four with the upper left-hand chart, which details the substantial changes in the Treasury yield curve over the past year. As inflationary measures continued to push higher into the first quarter of 2022, the Federal Reserve was compelled to respond by adjusting their focus since the onset of the COVID-19 pandemic from supporting maximum employment to fighting the highest inflation in 40 years. Treasury yields increased across the curve, with short-end yields increasing more than long-end rates, given expectations for significant tightening of monetary policy over the next 12-18 months. The move higher in yields has continued into the second quarter, as evidenced by the pink line.
Funding rates, as indicated in the upper right-hand chart, have closely followed expectations for changes in the federal funds rate, sharply increasing from very low levels beginning in January as the market predicted the first rate hike of this cycle at the March FOMC meeting. Fed Funds futures markets have increasingly priced in expectations for further tightening, projecting a terminal federal funds rate over 3% by the end of 2023. Meanwhile, the Federal Reserve and U.S. commercial banks continued to add Agency mortgages to their balance sheets into March as quantitative easing ended with net Agency MBS purchases dropping to zero by mid-month. The Federal Reserve now owns $2.7 trillion Agency MBS, which alone represents nearly 40% of the almost $7 trillion market. Moving on to slide five, where we provide more detail on the Agency MBS market.
In the upper left-hand chart, we show Agency MBS performance versus swap hedges since the third quarter of 2021 in generic 30-year, 2%, 2.5%, and 3% coupons, highlighting the first quarter of 2022 in gray. All three coupons underperformed sharply during the quarter, given escalating volatility due to the significant changes in expectations for monetary policy and the Russian invasion of Ukraine. Minutes from the December FOMC meeting were released in early January, setting the table for a much more rapid shift from quantitative easing to quantitative tightening, as expectations for the timeline of balance sheet normalization accelerated measurably. Initially, the market was expecting a much longer delay, similar to the end of QE3. Furthermore, market concerns on the potential for sales from the Fed's balance sheet sparked additional deterioration in Agency MBS valuations.
By the end of April, the asset class had experienced its most significant cheapening since the financial crisis, with 30-year current coupon nominal spread to Treasuries increasing over 100 basis points since May 2021, shown in the bottom left chart. Sharply higher mortgage rates have pushed refinancing activity near the lows of the past 20 years, and as a result, the value of prepayment protection on specified pools has collapsed, as indicated by the decline in payoffs in the top right chart. In the bottom right chart, implied financing rates on lower coupon TBA increased as Fed purchases declined, given the conclusion of net purchases. Attractive implied financing rates and production coupons should persist in the coming months. Although we expect some deterioration as the supply and demand technicals worsen in the second half of the year.
Given yesterday's FOMC meeting and Chairman Powell's press conference, the Federal Reserve is set to reduce the Agency MBS portion of its balance sheet via paydowns, beginning with a monthly cap of $17.5 billion in June, which will increase to $35 billion in September. Mortgages responded well to the announcement as the ramp to the $35 billion cap is shallower than expected, leading to more reinvestment in the coming months. In addition, there was no mention of asset sales from the balance sheet, which the market interpreted as a signal that potential sales are far into the future and not currently being contemplated by the Fed. Slide six provides detail on our Agency MBS investments and the changes in the portfolio during the first quarter.
We significantly reduced our allocation to Agency MBS through outright sales of lower coupon securities and paydowns on the total portfolio, given the continued challenges in the sector. While the earnings capacity of the company remained robust through attractive funding rates and relatively slow prepayment speeds. In addition, we continued to actively manage our overall allocation, reducing our exposure to 30-year, 2%, 2.5%, and 3% coupons in favor of those higher in the coupon stack, while also rotating a portion of our holdings into more attractive collateral stories such as low balance, which provides benefits in both premium and discount environments. Despite moving up in coupon, the weighted average pay-up on our specified pool holdings fell to 0.3 points as demand for prepayment protection declined, given falling prepay speeds and higher mortgage rates.
The modest increase in TBA allocation in the bottom chart is a result of the smaller specified pool portfolio, and we expect to decrease our allocation to TBA in subsequent quarters, given the expectation for deterioration in the dollar roll market. The weighted average yield on our agency MBS holdings increased 47 basis points to 2.54% as of quarter end, as our rotation into higher coupons and modestly slower prepayments on our specified pools supported the earnings power of the portfolio. Although we have seen a decline in the attractiveness of the dollar roll market in lower coupon TBA, production coupon TBA remains attractive, and we believe wider spreads on specified pools represent attractive investment opportunities. Current ROEs on production coupon dollar roll are in the mid to high teens, while specified pool ROEs are in the low teens.
We believe this trend will continue in the coming months as dollar roll and specified pool ROEs converge. Slide seven is an update on activity in our Agency MBS portfolio through the end of April. As indicated in the chart on the top, we have accelerated the reduction in exposure to the asset class, which largely began as the Fed pivoted to a significantly tighter monetary stance in the fourth quarter of 2021. In addition to the reduction in the overall allocation, we have diversified the coupon distribution substantially as the rise in mortgage rates since year-end provided an opportunity to invest proceeds of sales in lower coupons into more attractive options higher in the coupon stack, given new production in those coupons.
Despite the reduction in the portfolio, the rotation into higher-yielding production coupons, slowing prepayment speeds, and an attractive environment in funding markets continues to support Earnings Available for Distribution. Our remaining credit investments are detailed on slide eight, with non-agency CMBS representing 63% of the $98 million portfolio. Our allocation to credit securities remained stable during the quarter, with no asset sales and limited price movements overall. Our $70 million of remaining credit securities are high quality, with 90% rated single A or higher, and we remain comfortable with the credit profile of our remaining holdings. Although we anticipate limited near-term price appreciation, we believe these assets are attractive holdings as 100% are held on an unlevered basis and provide attractive unlevered yields.
Lastly, slide nine details our funding book at quarter end, as shown in the chart on the upper left. Repurchase agreements collateralized by Agency RMBS declined to $5.8 billion as of March 31st, given the reduction in our specified pool holdings, and hedges associated with those borrowings also declined to $4.5 billion net notional of pay fixed to receive floating interest rate swaps. In order to hedge additional exposures further out the yield curve, we continue to hold $1.3 billion notional of forward-starting interest rate swaps with starting dates in 2023. Our weighted average repo costs increased 23 basis points to 37 basis points and have continued to climb higher as the funding markets price in tighter monetary policy in the coming months.
Our economic leverage when including TBA exposure increased modestly during the quarter to 6.5x debt to equity due to the decline in book value. Post quarter end, the reduction in the portfolio brought economic leverage modestly below 6x debt to equity as of April 30th, as we remain focused on reducing risk in the Agency MBS sector. To conclude our prepared remarks, significant challenges in the Agency MBS market persist, and we're actively reducing risk in order to preserve book value, maintain flexibility, and ensure we're well-positioned to capitalize on opportunities when downward pressure on valuations eases. The worsening supply and demand technicals are likely to pressure spreads wider in the near term, as we believe fair value given balance sheet runoff is approximately 10 basis points-15 basis points wider from current levels.
Outright sales from the Fed's balance sheet will likely remain an option as inflation remains elevated, we do not believe this to be a 2022 event and would expect outright sales to remain a low probability event if inflation moderates as expected in the second half of the year. In the meantime, we will remain conservatively positioned and ready to take advantage of more attractive entry points in the future. 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 then one. Remember to unmute your phone and record your name when prompted. If you'd like to withdraw your question, you may press star two. Our first question comes from Doug Harter with Credit Suisse. Your line is open.
Hi, this is John Kilichowski on for Doug. I guess first question now with the smaller asset base, what is the outlook for the future of the dividend now? Kind of as you can see pressure there with needing higher returns.
First of all, a dividend policy set by our board, based on where we expect Earnings Available for Distribution to be over the coming quarters. It's always difficult to comment on any potential dividend decisions in advance. That said, you know, EAD came in well above the dividend this quarter at $0.12 versus $0.09, mainly because of slowing speeds and higher reinvestment rates as we rotated into higher coupons, particularly production coupon dollar roll. Looking ahead, you know, over the next couple quarters, we anticipate that EAD will be impacted by lower leverage, but also by higher reinvestment rates offered by wider mortgage spreads as we continue to rotate into higher coupons.
You know, we also expect that as the mortgage basis becomes more attractive, going forward, we'll look to begin to lever up again, which would also be supportive. You know, that's kind of where we see things going.
Got it. Thank you. Second question would just be, you know, I know it's kind of a crystal ball question, but we talked about this last quarter where we thought, you know, how much wider spreads can go. I feel like the commentary now this quarter is roughly similar even though we've already seen them kind of widen beyond that. What's your timeline and what's kind of your policy right now around kind of book value protection while spreads are kind of in this volatile space? Where are marginal dollars looking to go? When do you think we can start to expect leverage to be taken up?
Yeah, thanks. This is Brian. Yeah, that's a difficult question to answer. Clearly, there's a lot of volatility. You know, the Fed just met yesterday with their announcement. You know, like I said, mortgages responded pretty well to that just because there's, you know, gonna be more demand over the next few months than what was originally expected. Spreads are gonna be fairly well supported during that time frame. You know, we still think that, you know, supply and demand is gonna be challenged as we move forward. You know, and you know, spreads are gonna react to the probability of asset sales in the future. You know, that probability has come down.
Some mortgages have done well, but, you know, if inflation remains elevated, then we expect that probability will increase in the future and that spreads would widen as a response to that. It's tough to say. You know, I think right now just given the volatility and the uncertainty about the Fed path, you know, we're gonna remain pretty conservatively positioned until that becomes more clear.
Great.
Oh, yeah. The marginal dollar is gonna, you know, likely go into production coupons, which are, you know, more like 30-year 4s and 4.5s, currently.
Got it. Thank you.
Our next question comes from Jason Stewart with JonesTrading. Your line is open.
Hey, good morning. Thank you. I was hoping you could give us an update on your thoughts around portfolio diversification if that, you know, either a timeline or an asset class that's sort of coming to fruition there?
You know, first of all, we still believe in the hybrid model. Obviously benefits that come from asset diversification are very important. You know, we're still looking at different opportunities. The objective with any new investment strategy is going to be to mitigate some of the risks inherent in the current portfolio. We're looking at opportunities that require lower leverage and in particular avoiding short-term market-to-market leverage. Strategies that contribute a greater book value stability would also be beneficial. Of course, expected returns need to be attractive. You know, that's kind of what we're looking at, but nothing to report as of right now.
Okay, fair enough. I wanted to follow up on the TBA dollar roll comments that you made. It sounds like you expect production coupon rolls to remain strong up until some point. Is that point when the Fed is actively out of the market and letting runoff happen, so in June? Or do you think dollar roll could persist in that mid-teens post-June on production coupons?
Yeah, we think production coupon dollar roll can remain pretty well supported. You know, I think these bonds are really just now being produced just given how fast the mortgage rate has moved up. Fours, 4.5s, and eventually even fives, there's just not a lot of bonds out there right now. You know, that's the reason why the TBA is so attractive because there's a lot of demand for exposure there, but there's just no bonds to deliver. We think that can persist for quite a bit. You know, the other benefit is that you know, brand-new bonds don't pay very fast, right?
It's going to take some time for those to ramp up into higher CPRs, which would then lead to a less attractive TBA environment. You know, we think, you know, I don't want to get too far ahead of myself, but, you know, over the next quarter or two that they can remain relatively attractive.
Okay, great. I guess just to put a point on that, your comment was that you expect the TBA portfolio to be smaller, versus vis-à-vis, say, 4Q or 1Q and 2Q and 3Q. Is that what your point was?
Yes, that's right. Yes. Yeah, I mean, the overall portfolio is smaller too, right? You know, we've reduced TBA just, given that we're no longer invested in those lower coupon TBA, and we've moved higher coupon. You know, given the overall size of the portfolio is smaller than we expect, the TBAs will fall too.
Got it. Great. Thanks a lot.
Yep.
As another quick reminder, if you'd like to ask a question, please press star then one. One moment to see if we have any more questions. Showing none.
Okay. Well, like to thank everybody for joining us on the call, and look forward to speaking to you next quarter. Thanks.
Thank you. That concludes today's conference. You may all disconnect at this time.