Earnings Transcript for IVR-PB - Q4 Fiscal Year 2024

Operator: Welcome to the Invesco Mortgage Capital Inc. Fourth Quarter 2024 Earnings Call. All participants will be in a listen-only mode until the question and answer session. As a reminder, this call is being recorded. Now I would like to turn the call over to Greg Seals in Investor Relations. Mr. Seals, you may begin the call.

Greg Seals: Thanks, operator, and to all of you joining us on Invesco Mortgage Capital Inc.'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, invescomortgagecapital.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 two of the presentation regarding these statements and measures as well as the appendix for the appropriate reconciliations to GAAP. Finally, Invesco Mortgage Capital Inc. 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. Thank you for joining us today. I'll now turn the call over to IVR's CEO, John Anzalone.

John Anzalone: Good morning, and welcome to Invesco Mortgage Capital Inc.'s fourth quarter earnings call. I'll provide some brief comments before turning the call over to our Chief Investment Officer, Brian Norris, to discuss our portfolio in more detail. Also joining us on the call this morning for Q&A are our President, Kevin Collins, our COO, Dave Weil, and our CFO, Mark Griggson. Long-term treasury yields ended the quarter sharply higher as the disinflationary trend stalled. Market participants dealt with fresh uncertainty regarding the impacts of future monetary, fiscal, and trade policies. Expectations for future inflation reflected in TIPS breakevens rose over the course of the quarter with the two-year breakeven ending the year at 2.54%, up from 1.77% in September. This trend has continued into this year as the two-year breakeven is now comfortably above 3%. These uncertainties combined with the robust labor market led to a recalibration of the market's expectations for future monetary policy. All in all, 100 basis points of reductions in the federal funds target rate over the course of the third and fourth quarters. Futures market expectations as of year-end 2024 reflected only one to two additional cuts in the target rate through the end of 2025. This compares to an expectation of ten cuts through the end of 2025 priced in as recently as mid-September. Against this macroeconomic backdrop, agency RMBS underperformed treasury during the fourth quarter. Underperformance during the quarter primarily took place in lower coupons as a sharp move higher in interest rates limited demand for discount securities. Although the industry volatility moved higher during the quarter, supply and demand technicals for higher coupon agency mortgages were supported as supply was limited while bank and overseas demand improved. Canadian fees largely remained at low levels given limited housing activity and elevated mortgage rates. Premiums on higher coupon specified pool collateral declined modestly given the increase in interest rates but remained relatively well supported as implied financing via the dollar roll market TBA investments remained largely unattractive throughout the quarter. Agency CMBS risk premiums contracted notably during the fourth quarter given increased optimism regarding renewed bank demand for stable cash flow profiles in this elevated interest rate volatility and relatively modest new issuance. Against this backdrop, book value per common share decreased 4.8% to $8.92 per share, and when combined with our $0.40 per share common stock dividend, resulted in an economic return of a negative 0.5% for the quarter. As mentioned, 2025 agency mortgage performance has been modestly positive with interest rate volatility stabilizing as the market's outlook for future monetary policy has coalesced around one or two additional cuts in the FOMC this year. As of February 14, 2025, we estimate our book value per common share to be between $8.90 and $9.26 per share. We notably improved our capital structure and reduced our cost of capital by funding the redemption of our Series E preferred stock in December, primarily with lower-cost repurchase agreements. As a result, our debt-to-equity ratio increased to 6.7 times at the end of the fourth quarter, up from 6.1 times at the end of the third quarter. At the end of the year, approximately 85% of our $5.4 billion investment portfolio was invested in agency mortgages, and 15% was invested in agency CMBS. We maintained a sizable balance of unrestricted cash and unencumbered investments totaling $389 million. Our earnings available for distribution declined from $0.68 in the third quarter to $0.53 in the fourth quarter as we recognized a one-time charge associated with the redemption of our Series B preferred stock. In addition, we diversified the composition of our interest rate hedges, reducing our exposure to changes in swap spreads by increasing our allocation to US treasury futures. While this negatively impacted our effective net interest income for the quarter, we stand to benefit from future normalization of the yield curve. In the near term, we remain cautious on agency mortgages as shifting expectations for monetary and fiscal policy may result in elevated interest rate volatility, reducing investor demand. Our long-term outlook for agency mortgages is favorable, however, as we expect demand to improve in higher coupons given attractive valuations and eventual decline in interest rate volatility and a steeper yield curve. Lastly, we expect a gradual increase in agency CMBS new issuance to be met with robust investor demand as the sector continues to offer value relative to other fixed income investments due to its prepayment protection and attractive risk-adjusted return profiles. Now I'll turn the call over to Brian Norris to go through the portfolio in more detail.

Brian Norris: Thanks, John, and good morning to everyone listening to the call. I'll begin on slide four, which provides an overview of the interest rates and agency mortgage markets. As shown on the chart in the upper left, during the fourth quarter, US treasury yields rose across the yield curve, with two-year and longer maturities increasing between 60 and 85 basis points. Most of the increase occurred in the first half of the quarter, driven by market expectations of a Republican sweep in the November elections. The chart on the bottom left provides Fed funds futures market pricing since the beginning of 2024. The number of cuts to the Fed funds target rate in 2024 was much less than projected at the beginning of the year, as economic growth, employment, and inflation data proved to be more resilient than anticipated. The market is now pricing in only one or two cuts in 2025 along with a much higher terminal rate over the next few years. The chart in the upper right reflects changes in the short-term funding rates over the past year. During the fourth quarter, funding rates declined in line with monetary policy easing, but repo rates exhibited some volatility at year-end. Positively, the repo market has normalized since year-end, with one-month agency MBS repo spreads declining modestly from SOFR plus 20 to SOFR plus 15 basis points. Lastly, the bottom right chart details the agency MBS holdings by the Federal Reserve and US banks. Runoff of the Fed's balance sheet continues, with agency RMBS declining by approximately $15 to $20 billion per month. Quantitative tightening is expected to persist at the current pace in the near term, potentially ending in the second half of 2025. US banks added nearly $50 billion to their portfolios in the second half of 2024, and we expect bank demand for agency RMBS to continue at a notable pace as deregulation and a steeper yield curve provide an attractive environment for deployment of deposits. Slide five provides more detail on the agency mortgage market. In the upper left chart, we show 30-year current coupon performance versus US Treasury since year-end, highlighting the fourth quarter in gray. Current coupons underperformed during the quarter due to a sharp rise in interest rates. This increase in interest rate volatility reduced investor demand for agency mortgages. In addition, nominal spreads on current coupons were quite volatile in the first half of the fourth quarter but stabilized over the last couple of months due to decreased interest rate volatility and favorable supply and demand dynamics. In the chart on the upper right, we show specified pool payouts over the past year, which declined since the end of the third quarter as prepayment protection became less valuable as mortgage rates remained elevated. Lastly, as shown in the lower right chart, funding via the dollar roll market for TBA securities has improved with implied funding rates lower than SOFR across several coupons. While we continue to prefer specified pools over TBA given their more predictable prepayment behavior, the improvement in the dollar roll market for TBA securities has reduced the difference in returns compared to specified pools funded via repo. Slide six details our agency RMBS investments and summarizes the investment portfolio changes during the quarter. Our agency RMBS portfolio decreased 11% quarter over quarter as we sold a portion of our lower coupon specified pools to manage leverage early in the fourth quarter and to fund purchases in agency CMBS. Overall, we remain focused on higher coupon agency RMBS, which should see greater benefit from a decline in interest rate volatility and are largely insulated from direct exposure to assets held by commercial banks and on the Federal Reserve's balance sheet. We focus our specified pool allocation on prepayment characteristics that are expected to perform well in both premium and discount environments, with our largest concentration in lower loan balance collateral giving more predictable prepayments. We increased our allocation to specified pools with low credit score borrowers during the quarter, particularly as we added to higher coupons given the attractive relative value in lower pay-up stories and higher coupons. Although we anticipate interest rate volatility to remain moderately elevated in the near term, we believe current valuations on production coupon agency RMBS largely reflect and continue to represent attractive investment opportunities, with current gross ROEs in the mid to high teens. Slide seven provides detail on our agency CMBS portfolio. We purchased $181 million at the beginning of the fourth quarter, bringing our exposure to the asset class to approximately 15% of our total investment portfolio. We believe agency CMBS offers many benefits, mainly through its prepayment protection and fixed maturities, reducing our sensitivity to interest rate volatility. Gross ROEs on our new purchases were in the low double digits, and we have been disciplined on adding exposure only when the relative value between agency CMBS and agency RMBS accurately reflects their different risks. Financing capacity has been robust as we have been able to finance our purchases with multiple counterparties at attractive levels. We will continue to monitor the sector for opportunities to increase our allocation as they become available, recognizing the overall benefits to the portfolio as the sector diversifies risks associated with an agency RMBS portfolio. Our agency CMO allocation is detailed alongside our remaining credit investments. Our allocation to both agency interest-only and credit securities remains largely unchanged, with $71 million allocated to agency IO and $17 million allocated to credit at quarter-end. Although we anticipate limited near-term price appreciation in these investments, we believe they provide attractive yields for unlevered holdings with returns in the high single digits. Slide nine details our funding and hedge book at quarter-end. Repurchase agreements collateralized by our agency RMBS and agency CMBS investments declined from $5.2 billion to $4.9 billion, consistent with a modest decrease in our total assets, while the total notional of our hedges increased from $4.3 billion to $4.7 billion. The decrease in our repo balance and increase in our hedge notional resulted in a higher hedge ratio for the quarter, from 83% to 95%, reflecting our expectation of fewer cuts in the Fed funds target rate in 2025. The table on the right provides further detail on our hedges at year-end. We continue to increase our hedge exposures in treasury futures during the fourth quarter as we sought to decrease our exposure to swap spreads. At year-end, our notional balance of treasury futures was 30% of the total hedge notional balance, up from 11% at the end of the third quarter. Slide ten provides more detail on our capital structure and highlights the improvements made in the fourth quarter subsequent to the redemption of our Series B preferred stock. The redemption was funded largely via an increase in repurchase agreements, which had a lower cost of capital than our Series B preferred stock. Further improvement in the capital structure remains a focus of ours as we seek to reduce our cost of capital and improve shareholder returns. To conclude our prepared remarks, financial markets were quite volatile in the fourth quarter as investors began to price in greater monetary and fiscal policy uncertainty, but our focus on higher coupon agency RMBS and increased allocation to agency CMBS mitigated much of this impact and resulted in an economic return of negative 0.5%. Positively, this volatility has dissipated thus far in 2025, providing a supportive backdrop for our investments and resulting in an increase in our book value of approximately 2% excluding the dividend approval as of last Friday. We believe Invesco Mortgage Capital Inc. is well-positioned to navigate current mortgage market volatility given our moderate leverage and robust liquidity. We continue to selectively capitalize on historically attractive agency RMBS spreads and believe the sector is poised to perform well as interest rate volatility continues to moderate. Our liquidity position provides substantial cushion for further potential market stress while also providing capital to deploy into our target assets as the investment environment improves. In addition, we believe further easing of monetary policy will lead to a steeper yield curve and decline in interest rate volatility, both of which provide a supportive backdrop for agency mortgages as they improve demand from commercial banks, overseas investors, money managers, and REITs. Thank you for your continued support for Invesco Mortgage Capital Inc. Now we will open the line for Q&A.

Operator: Thank you. We will now begin the question and answer session. You will be prompted to record your name. To withdraw your question, you may press star two. Again, please press star one to ask a question. Our first question comes from Doug Harter with UBS. Your line is open.

Doug Harter: Thanks. Hoping you could talk about how you are viewing, you know, kind of the risk-reward trade-off of agency RMBS and agency CMBS, especially in light of the current dividend level.

Brian Norris: Yeah. Hey, Doug. It's Brian. Yeah. We are, you know, if you go back to slide seven, you can see, you know, when spreads are on agency CMBS, are in the kind of high fifty sixty area. That tends to be relatively attractive versus where mortgages were. So we did add most of our agency CMBS exposure kinda at the beginning of the fourth quarter. But as spreads tightened from there, it became a bit less attractive, particularly as agency mortgages were underperforming during that time. You know, that difference has certainly compressed here in the first quarter. Agency CMBS spreads are just a touch wider, while agency mortgages have performed pretty well. So, you know, I think the benefits that agency CMBS provides to our portfolio are still supportive. But given that volatility has declined pretty notably here so far in the first quarter, you know, the lean is certainly towards agency RMBS at the current time.

Doug Harter: Great. And, you know, I guess with that blend and kinda where, you know, all spreads are. You know, can you just talk about your comfort in the current dividend level?

John Anzalone: Yeah, Doug. It's John. Hi. Yeah. I mean, obviously, you know, our board recommends it. Or we recommend our dividend report or approves it. That'll happen over the next month. You know, I mean, we look at a number of factors, you know, first and foremost is, you know, where our current and near-term to medium-term projected ROEs are on investments. So, I mean, that's the, you know, that's the first thing. We would also look at where average, you know, sort of ROEs have been more historically over a longer time frame. And then also look at, you know, sort of the competitive environment where dividend yields are for that. So, I mean, those are all things we're gonna be taking a look at as we move over the course of the next month. Well, to Brian's point, I think, you know, we're we are pretty selective where we add agency CMBS. So we're not, you know, adding it much much lower than than where we're seeing agency RMBS. I mean, it's obviously the ROEs are a little bit lower because they don't have a convexity risk, so they should be a little bit lower. But that's that's kinda how we look at it.

Doug Harter: Great. I appreciate the answers.

Operator: Thank you. Our next question comes from Trevor Cranston with Citizens JMP. Your line is open.

Trevor Cranston: Hey. Thanks. On the changes you made to the hedge book this quarter, do you foresee making any incremental changes to the mix of the hedge position going forward? Thanks.

Brian Norris: Thanks, Trevor. It's Brian. Yeah. Certainly, there are trade-offs between the two. Given that swap spreads are currently negative, you know, the hedging with them is a bit cheaper, so ROEs are better when you hedge with swaps. But certainly, you know, volatility that we've seen in swap spreads over the past year or two adds more volatility to that hedging as well. So, you know, like I said, at the end of 2024, we were at 30% treasury futures. I think, you know, that's probably the high end given the current environment of where we'd like to be. You know, we have seen swap spreads widen so far in 2025. You know, it's, you know, swap spreads did tighten a lot in 2024 just given the expectation that treasury issuance would be substantial as we move forward here. You know, but there's some uncertainty there. I think a lot of things that have happened so far in 2025 is just that the new administration is maybe a little bit slower to roll out some of the things that were once feared. So you've seen volatility come down, swap spreads have widened a bit. So, you know, it's there are trade-offs. Like I said, I think we would target probably 20 to 30% of treasury futures in the current environment. So, you know, we're right in that range currently. So, you know, as we move forward, I think, you know, we'll still be monitoring swap spreads, obviously, but again, where they are now, I think we're pretty comfortable with where we are.

Trevor Cranston: Okay. Got it. Appreciate the call. Thank you.

Operator: Thank you. As a reminder, if you would like to ask a question, please press star one. Our next question comes from Jason Stewart with Janney. Your line is open.

Jason Stewart: Hey. Good morning. Thanks. I wanted to dig in a little bit more to your cautious outlook on agency mortgage and maybe if you could talk a little bit more about whether that's a rate-driven outlook or if there's a component of GSE reform baked into that cautious outlook. And maybe on the latter, if you do have a view on what's priced into the basis, in terms of GSE reform risk, that'd be helpful.

Brian Norris: Hey. Thanks, Jason. It's Brian. Yeah. I'll tackle GSE reform right off the bat here. You know, I think the market has not reacted at all to the headlines so far that we've seen on that topic. Mortgage spreads have tightened so that, you know, to the extent that there's any concern out there, it doesn't seem to be reflected. You know, I think that's notable because, you know, the market is essentially saying that, you know, the only thing that would really materially impact agency mortgage spreads would be, you know, a loss of the implicit or explicit guarantee on mortgages. And that remains an extremely remote scenario at this point. So, you know, I think spreads have responded accordingly by not pricing in any real concern about that at this current time. Our cautiousness is, you know, I mean, like I said, volatility has come down quite a bit in 2025. Mortgage spreads have tightened. So, you know, I think there's still a fair amount of monetary and fiscal policy uncertainty out there. Trade policy uncertainty. So, yeah, I think we're just, you know, with leverage, you know, our debt-to-equity ratio is right around nine. You know, I think we're comfortable in that situation. Spreads are attractive still. We can still earn attractive ROEs, like I said, in the mid to high teens at that level. So I think, you know, we're kind of, you know, we're not overly cautious. We still think mortgages will perform well through the year, but just given where we are right now. Yeah. I think, you know, mortgages have had a pretty good start to the year. So it's just a matter of whether volatility will continue to trend lower or if it kind of pauses and goes the other way.

Jason Stewart: Got it. Okay. That's helpful. And then you referenced on the refunding of the Series B, you know, moving that to repo. I mean, I guess the question is a big picture question. Is the right way to look at how are you looking at preferred today as a part of the capital structure? Is it more permanent capital in your mind? Should we be looking at that as leverage to preferred plus common? You know, has that shifted the way that you look at the capital structure? Has that shifted over the last year?

John Anzalone: Oh, hey. It's John. Yeah. No. I don't think it's shifted. I mean, we're still, I think, you know, if you look at us historically, you know, our portfolio mix was very different when we had when we put on the preferred. I think we had, you know, there was a time we had loans involved. We had securitizations, different asset classes. Made a little bit more sense having preferred, and then, you know, post-COVID, you know, it just became too much percentage of our capital structure. So I think, you know, we're still targeting, you know, we'd like to get back to the, you know, 20% ish range. You know, I think most of our peers are in, you know, around that range or about less even. At this point, we're still targeting that. You know, so that'll be a combination of, you know, either grow through ATM or equity issuance or and or continuing to chip away at repurchasing the preferred Series C's.

Jason Stewart: Okay. Alright. Thanks, John. Thanks, Brian.

Brian Norris: Thanks.

Operator: Thank you. At this time, we have no further questions. Speakers, I'll hand the call back to you.

John Anzalone: Great. Thank you very much, operator, and thank you everybody for joining the call today. Have a great day.

Operator: Thank you. That concludes today's conference. Thank you for participating. You may disconnect at this time.