Earnings Call: Q1 2021

May 6, 2021

Welcome to the Invesco Mortgage Capital Inc. First Quarter 2021 Investor Conference Call. All participants will be in a listen only mode until the question and answer session. Followed by the one on your telephone. As a reminder, this call is being recorded. Now, I would like to turn the call over to Jack Bateman in Investor Relations. Mr. Bateman, you may begin. Thank you, and welcome to the Investo Mortgage Capital Q1 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 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 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 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 investomortgagecapital.com and click on the Q1 2021 Earnings Presentation link under Investor Relations. Again, welcome and thank you for joining us today. I'll now turn the call over to Johnny Antalone. John? Good morning, and welcome to Invesco Mortgage Capital's 1st Quarter Earnings Call. I will give some brief comments before turning the call over to our Chief Investment Brian Norris to discuss the current portfolio in more detail. Also joining us on the call to participate in the Q and A are Exceeding our recently increased dividend of $0.09 per share and a penny better than last quarter. The increased core run rate reflects the benefit of having our portfolio Our book value was down 5.4 percent for the quarter to $3.65 per share. The decrease in book value reflected the underperformance of The combination of the increased dividend and the decline in book value produced an economic return of negative 3.1 percent for the quarter Since June 30, 2020 was 22.1%. During the quarter, Optimism around the prospects for increased economic activity was driven by the potential impact of stimulus programs, The continued rollout of vaccinations and the significant decline in new infections, while this renewed optimism was supportive of many risk markets through the quarter, Fixed income investors began pricing in the potential for higher inflation. In fact, we saw price increases across Commodities as well as in broader inflation gauges during the quarter and treasury breakeven rates, which reflect and in the long end of the yield curve. These factors contributed to the underperformance of lower coupon agency mortgages during the quarter, Despite continued strong demand from the Fed, while steeper curve and slowing prepayment speeds contribute to a better environment For prospective ROEs, these factors also caused repricing of pay ups on specified pool collateral as the value of prepayment protection decreased. Brian will get into the details in a minute, but we ended the quarter with 99% of our assets and 91% of our equity invested in agency mortgages, Reflecting the completed reallocation of the portfolio, our liquidity position remains strong as we had $693,000,000 of unrestricted cash and unencumbered assets Quarter end. As we look out over the next several quarters, we expect demand from the Federal Reserve and Commercial Banks to be Supportive evaluations despite relatively tight spreads, elevated interest rate volatility and an increase in net supply. Our focus on active management and security selection when purchasing specified pool collateral helps to mitigate these risks, and we believe a steeper yield curve, I'll stop Thanks, John, and good morning to everyone listening to the call. I'll begin on Slide 4, which details the changes in the U. S. Treasury yield curve during the Q1 in the upper left hand chart. The successful early rollout of between interest rate and equity market volatility as indicated by the blue dark blue line in the same chart is notable as equity markets continue to improve Despite the volatility in fixed income markets, the sharp move higher in interest rates and volatility negatively impacted our Agency RMBS valuations We detailed the growth in both Commercial Bank and Federal Reserve Holdings of Agency RMBS, which has been consistent and kept valuations relatively rich Our expectations for net supply in 2021 have increased to over $600,000,000,000 eclipsing 20 Keeping supply and demand dynamics in the sector, supportive of valuations in the coming quarters. Moving on to Slide 5, where we provide more detail on the Agency RMBS market. In the upper left hand chart, we show generic lower coupon Agency RMBS cumulative performance 1st, the swap hedges since June 30 last year, highlighting the Q1 of 2021 in gray. As you can see, strong Support from the Federal Reserve and Commercial Banks drove strong performance in 30 year 2% and 2.5% coupons in the second half of twenty twenty. However, the sharp increase in interest rates and volatility led to underperformance in the Q1, particularly in late February before recovering modestly in March. In addition, specified pool pay ups, as shown in the upper right, reflected Quarter and ended the Q1 sharply lower. The chart in the lower left shows the continued increase in prepayment speeds for lower As the impact from the increase in mortgage rates in February is unlikely to impact until the report for April is released later today. We expect prepayment speeds and lower coupons to slow meaningfully in the coming months, while higher Season loans that have yet to refinance. Finally, the lower right hand chart details the implied financing rate for dollar roll transactions in 30% or 2%, 2.5% and 3% TBAs. The implied financing rate is the reinvestment rate for which an investor is indifferent between taking delivery Increased during the quarter, modestly reducing the attractiveness in dollar rolls. Despite this decline, the dollar roll market remains Slide 6 provides detail on our Agency RMBS investments. As indicated in the upper left hand chart, in addition to the 15% allocation to Agency TBA, Price collateral stories mitigating our exposure to elevated pay ups and historically tight spreads as our We increased our investment in Agency RMBS inclusive of PBAs to $10,500,000,000 during the quarter, reflecting the deployment of proceeds from capital Lastly, we reduced our allocation to Agency TBA Investments by $200,000,000 notional given the modest decline in the attractiveness of the dollar roll market. Our specified pool holdings paid 6.3 As our relatively newly issued pools had a weighted average loan age of 4.3 months at quarter end, we anticipate expected prepayment As those coupons provide the most attractive combination of lower prepayment speeds and strong support via consistent Federal Reserve and commercial bank demand, but continue to search for attractive higher coupon options to diversify our asset composition. Our remaining credit investments are detailed on Slide 7 with non agency CMBS representing 66% of the $138,000,000 portfolio. The modest decline during the quarter is reflective of paydowns as the dispositions during 2020 have resulted in an appropriately sized Although we anticipate limited near term price appreciation given the significant improvements experienced since the lows were reached in the Q2 of 2020, We believe these assets are attractive holdings as 100% are held on an unlevered basis and provide attractive unlevered yields. Lastly, Slide 8 details the growth of our funding book during the Q1 as shown in the chart on the upper left. Repurchase agreements collateralized by Agency RMBS grew to $8,200,000,000 as of March 31, reflecting the growth in our total Given the successful deployment of proceeds from capital raises during the quarter into Agency RMBS assets. Edges associated with those borrowings remained unchanged during the quarter at $6,300,000,000 notional of fixed to 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 88% to 77% during the quarter. The weighted average interest rate on our hedge book remained unchanged at 41 basis points, While further improvements in the funding rates on our Agency RMBS holdings led to a weighted average funding rate of 15 basis points as of March 31. In order to mitigate the negative impact of rising interest rates on our new purchases, We entered into $1,300,000,000 notional of forward starting interest rate swaps with starting dates in 20222023 Concurrent with our expectations for potential adjustments in monetary policy, our economic leverage when including TBA To conclude our prepared remarks, we are very pleased with the transition of the portfolio since June 30, 2020 Q2 of 2020 reflects the benefits of our strategy and management's ability to provide attractive returns to our investors. Slowing prepayment speeds provide an improved environment for ROEs in the coming quarters. In addition, monetary policy remains very supportive. We expect that to continue throughout 2021 as the Federal Reserve communicates a desire to maintain an accommodative stance over the medium term. Lastly, our careful security selection and active management will mitigate the impact of potentially higher interest rate volatility as the Fed approaches Mikhail Goberman with JMP Securities, your line is open. Good morning. Thank you for taking my question. Just wanted to get a sense of maybe where you're seeing value trending thus far in the Q2. Thank you. Yes, this is John. Book value Has been relatively flat since quarter end. Okay. Thank you very much. That's all for me. I'm currently showing no additional questions. Jason George with JG Investments. Your line is open. My question is, do you see any more Headwinds in the future quarters like we had in Q1, for example, the steepening of The yield curve or higher market rates that will affect the portfolio? Yes, this is Brian. I think agency mortgage spreads are pretty tight. So Valuations are relatively rich, but practically the entire fixed income universe is pretty rich And valuation is pretty tight as well. So I think that will help keep a lid on Brett widening and also pretty strong demand from the Fed and commercial banks will also prevent a significant amount of But risks at this point, risks are likely to be skewed wider more so than tighter at this point. Okay. Well, I guess if there's no