Welcome to the Invesco Mortgage Capital second quarter 2021 investor conference call. All participants are in a listen-only mode until the question and answer session. At that time, to ask a question, please press star one on your telephone keypad. As a reminder, this call is being recorded. Now I would like to turn the call over to Jack Bateman, investor relations. Mr. Bateman, you may begin your call.
Thank you. Welcome to the Invesco Mortgage Capital second quarter 2021 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 that 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 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 Q2 2021 earnings presentation link under investor relations. Welcome, and thank you for joining us today. I'll now turn the call over to John Anzalone. John?
Good morning, welcome to Invesco Mortgage Capital second 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. Joining us on the Q&A are our President, Kevin Collins, our CFO, Lee Fegley, our COO, David Lyle. I'm pleased to announce earnings available for distribution for the second quarter came in at $0.10 per share. As we noted in our press release, we've replaced the term core earnings with earnings available for distribution. This is in keeping with changing industry conventions, does not reflect any change in how the measure is calculated.
Despite an extremely challenging quarter for agency mortgages, earnings available for distribution continue to be supported by strong dollar rolls, relatively slow prepayment speeds on our specified pool collateral, and a more favorable reinvestment environment. During the quarter, we made progress in rebalancing our capital structure by redeeming all $140 million of our Series A preferred stock and raising an additional $145.9 million of common equity. The portfolio remains predominantly agency-focused, with 92% of our equity and 99% of our assets allocated to agency mortgages. Our liquidity position remains strong as we held $651 million of unrestricted cash and unencumbered investments at quarter end.
Agency mortgages sharply underperformed during the quarter as elevated net supply, reduced demand from commercial banks, persistent prepayment concerns, and an increased likelihood that the Federal Reserve's timeline for reducing asset purchases would be accelerated more than offset steady Fed demand. Our book value performance reflected this underperformance, ending the quarter down 12% to $3.21. Looking ahead, many of the headwinds that the mortgage bass faced during the second quarter remain intact. Prepayment speeds moderated during the quarter but remain elevated, and a lower interest rate environment at quarter end should keep prepayments near historic highs over the coming months. Increases in inflation across many parts of the economy keep the uncertainty around the Fed's plan to taper its asset purchases at a heightened level.
While these factors remain challenging, we expect that the recent widening of spreads, along with a favorable funding environment through both traditional repo and via dollar rolls, to continue to help support the earnings power of our portfolio over the coming quarters. I'll stop here and let Brian go through the portfolio.
All right. Thanks, John, and good morning to everyone on the call. I'll begin on slide four in the upper left-hand chart, which details the changes in the U.S. Treasury yield curve since year-end. As indicated by the dark blue line, the second quarter ended with a partial reversal of the first quarter's sharp rise in long-term yields, resulting in a flattening of the yield curve. Market optimism, resulting largely from the successful rollout of COVID-19 vaccinations and reopening of the service sector, became a bit more muted after an uptick in cases due to the more contagious Delta variant. In addition, the Federal Reserve successfully dampened the market's initial concern regarding the notable increase in year-over-year inflation by effectively communicating their projections for a softening of inflation pressures as the reopening of the economy moves forward.
As noted, these adjustments resulted in a bull flattening of the yield curve as short-term interest rates with three years or less to maturity increased by a modest five to 10 basis points, while longer-term 10 to 30-year rates declined approximately 30 basis points. This move was exacerbated by short covering in the interest rate swap market as positions designed to benefit from a move higher in rates were forced to unwind, resulting in tighter swap spreads during the quarter, as indicated by the chart in the lower left-hand section of slide four. Both the flatter yield curve and tighter swap spreads had negative ramifications for the Agency RMBS market, despite a continuation of attractive funding rates, as indicated in the upper right-hand chart, and strong demand from both the Federal Reserve and commercial banks, indicated in the lower right-hand chart.
Moving on to slide five, where we provide more detail on the Agency RMBS market. In the upper left-hand chart, we show year-to-date generic lower coupon Agency RMBS performance versus swap hedges. Highlighting the second quarter in gray. As you can see, agency mortgages underperformed sharply in May and June, offsetting modest gains in April, as the flatter yield curve led to reduced demand from commercial banks, while the decrease in the 30-year mortgage rate increased prepayment concerns. Agency MBS investors, given the sharp economic recovery and hawkish commentary from non-voting FOMC members, began to price in the potential for an earlier than expected tapering of asset purchases, including the possibility of a faster pace or earlier start in Agency RMBS relative to U.S. Treasury purchases.
In addition, net supply remained elevated, totaling $290 billion during the quarter, which was double the annual average during the 10-year period from 2010 to 2019. The $470 billion of net supply during the first half of 2021 nearly matches the $508 billion of net supply for the full year 2020. Although we expect the pace of net issuance to decline during the second half of the year, 2021 annual market projections have increased to over $700 billion, far surpassing 2020's record total. Specified pool payoffs, as shown in the upper right, were relatively unchanged after significant underperformance in the first quarter, as prepayment speeds showed a modest decline from elevated levels, given the typical lag from higher mortgage rates in February and March. We expect the recent decline in mortgage rates, combined with the strength of the housing market, to keep prepayment speeds elevated in the coming months.
Lastly, the lower right-hand chart details the implied financing rate for dollar roll transactions in 30-year 2%, 2.5%, and 3% TBAs. The implied financing rate is the reinvestment rate for which an investor is indifferent between taking delivery of a mortgage pool or rolling the TBA contract forward one month. As indicated in the chart, implied financing rates improved during the quarter as the yield curve flattened, increasing the attractiveness of the dollar roll market for investors in lower coupons. Slide six provides detail on our Agency RMBS investments and our activity during the second quarter. Elevated valuations early in the quarter, combined with increasing headwinds in the sector, prompted us to reduce exposure to Agency RMBS through a combination of asset sales and prepayments. As indicated in the upper left-hand chart, our exposures remained focused in lower coupons 30-year 2% and 2.5% specified pools and TBA.
However, we moved modestly higher in the coupon stack as cheaper valuations in 30-year 3% provided an attractive entry point. During the quarter, we purchased $1.6 billion of 30-year 3% specified pools, funded by sales of 30-year 2.5% pools, as higher rates and wider spreads improved projected returns in higher coupons. During the quarter, we continued to rotate into lower payoff specified pools, as we remain focused on mitigating our exposure to elevated payoffs. As indicated in the chart at the bottom of slide six, we sold higher payoff stories such as loan balance and GEO, while increasing allocations to lower payoff new production, high LTV, and low FICO stories. Our specified pool holdings had a weighted average payoff of 0.6 points as of 6/30, a modest increase from a half a point as of 3/31, reflective of our move into higher coupons.
The weighted average yield on our Agency RMBS holdings improved 16 basis points to 2.04% as of quarter end, while prepayments on our holdings remained low at 6.4 CPR for the quarter. We believe the strength of the dollar roll market and wider spreads present attractive entry points, with ROEs on lower coupon dollar rolls in the mid-teens and specified pools ranging from 9%-11%. Our remaining credit assets are attractive holdings, as 100% are held on an unlevered basis and provide attractive unlevered yields. Lastly, slide eight details our funding book at quarter end, as shown in the chart on the upper left. Repurchase agreements collateralized by Agency RMBS declined to $7.9 billion as of June 30th, given the modest decline in our holdings.
Hedges associated with those borrowings decreased to a net $5.3 billion notional of pay fix, receive floating interest rate swaps, as further confidence in the duration of the Federal Reserve's accommodative monetary policy stance provided an opportunity to reduce our hedge ratio from 77%-67% during the quarter. The weighted average interest rate on our hedge book remained unchanged at 0.41%, while further improvements in Agency RMBS borrowing costs led to a decline in our weighted average funding rate to 0.1% as of June 30th. In order to hedge additional exposures further out the yield curve, we held $1.3 billion notional of forward-starting interest rate swaps, with starting dates in 2023, concurrent with our expectations for potential adjustments in monetary policy.
Our economic leverage when including TBA exposure ticked modestly higher during the quarter to 6.8 times debt to equity, as we remain conservatively positioned. Five worst quarters for relative performance since the European debt crisis in the fall of 2011. Combined with the underperformance in the 1st quarter, one of the worst six-month returns since 2008. Although Agency RMBS valuations remain at relatively high levels on a historical basis, we believe elevated valuations in other high-quality fixed income alternatives should keep any potential for further Agency RMBS underperformance relatively muted compared to the first half of the year. Positively, net supply should wane as we move into the second half of the year, and strong bank and Federal Reserve demand should continue to support the market, with current expectations of early 2022 for the beginning of a taper in asset purchases.
Thank you for your continued support for Invesco Mortgage Capital. Now we will open the line for Q&A.
The first question is coming from Doug Harter of Credit Suisse.
Morning, everyone. This is Josh on for Doug.
This is Brian. We've seen about 25 basis points of widening from the tights that we saw in mid-May. The expectation is that we'll probably see another 10-15 basis points of widening. That's not necessarily going to occur before tapering begins, but kind of throughout the process. We think that any further widening will be much more gradual than what we saw during the second quarter. I think ultimately about 40 basis points wider from the tights that we saw in May is a reasonable assumption over the next, call it, couple of quarters.
Great. Makes sense. Thanks for that, Brian. Curious if you could give us an update on how book value has trended quarter to date. Thank you.
Yeah. Quarter to date, we're roughly down about 2%.
Great. Thanks so much for the comments.
Yep.
Once again, if you do have a question, please press star one on your telephone keypad. The next question is coming from Trevor Cranston, JMP Securities.
Hey, thanks. Good morning. I was wondering if you can talk about your outlook for prepay speeds with rates continuing to fall in July, the removal of the Adverse Market Refinance Fee, and specifically, how responsive you think the coupons you guys own would be to mortgage rates dropping back meaningfully below 3%.
Hey, Trevor, this is Brian. I think generically speaking for the market, we expect prepayment speeds to remain fairly elevated. As you noted, I think the 30-year mortgage rate is around 2.80 now. Certainly it's dropped 40 or 50 basis points from March levels. We think that prepayment speeds, particularly in 2.5 coupons and higher, are going to remain elevated. For our bonds, we continue to see pretty low levels of prepayments, and that's partially due to the lack of seasoning of our holdings. We do expect that to drift a little bit higher. We don't expect it to be too dramatic. We still have a fair amount of our holdings in 2% pools, which we expect to continue to pay relatively slow at these rate levels. If we were to move even lower, that could come into question.
We expect our 2.5 and 3% pools to drift a little bit higher from here, but our 2s to be relatively stable.
Got it. Okay, that's helpful. With respect to the interest rate environment, it seems like Agency spreads have been more stable in the third quarter as rates have come down. I was just curious to get your thoughts on how you think MBS would generally perform if the tenor does continue to move lower and the yield curve flattens. Conversely, how you think they'd perform if we get a back up in rates again.
The widening that we've seen since quarter end has been a little bit more gradual, as we noted, relative to kind of the second half of the second quarter. Mortgages should continue to underperform into bull flatteners as longer rates continue to rally. Conversely, I think mortgages could do okay. I think banks have a decent amount of cash to put to work, so they're just waiting for kind of a modest backup in rates, and mortgages should handle that pretty well.
Okay. Got it. Appreciate the comment. Thank you.
The next question is coming from Jason Stewart, JonesTrading. Your line is open.
Hey, good morning. Thanks for taking the question. Quick follow-up on the FHFA changes. How are you thinking about what Sandra Thompson may or may not do in positioning the portfolio for any potential impact?
Yeah. We do think that the changes at the FHFA should be more borrower-friendly, which means that it should be easier for higher coupon borrowers and lower credit borrowers to refinance. That means that higher coupons should continue to see elevated prepayments, particularly at these rate levels. We've avoided anything higher than 3% coupon, and we think that those coupons will continue to struggle in this environment.
Okay. Do you have a house view on how the policy evolves from this point going forward?
As far as conservatorship, I think that they're clearly going to approach that more slowly than the previous administration. I think we have a fair amount of time. Again, I think the new policies will be more geared towards being borrower-friendly and increasing access to these lower mortgage rates.
Okay. Appreciate it. Thanks.
Yep.
At this time, we have no further questions. Thank you.
Okay. Well, I'd like to thank everybody for joining us on the call. We look forward to talking to you next quarter. Thanks.
This will conclude today's conference. All parties may disconnect at this time.