INVESCO MORTGAGE CAPITAL INC

At that time, to ask a question, press the star followed by the one on your telephone. As a reminder, this call is being recorded. Now I'd like to turn the call over to Greg Seals at Investor Relations. Mr. Seals, you may begin the call.

Thanks, 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, 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 is not responsible for and is not added or guaranteed 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. I'll now turn the call over to John Anzalone.

John? Good morning and welcome to Investo Mortgage Capital's third 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 are President Kevin Collins, our CFO Lee Fedley, and our COO Dave Lyle. The market environment was extremely challenging during the third quarter, given shifting expectations for fiscal and monetary policy. Interest rate volatility remained elevated while treasury yields increased to their highest levels since 2007. This backdrop was particularly difficult for agency mortgages. as spreads reached multi-year-wise across the coupon stack and specified pool pay-ups declined. These conditions contributed to a 17% decline in our book value per share for the quarter. Elevated volatility and rising interest rates continued into the first few weeks of the fourth quarter, accelerating agency mortgage underperformance. Settlement turned more positive last week, fueled by investors' growing confidence that the FOMC's tightening cycle has ended. Positively, investors seeking to capitalize on historically cheap agency mortgage valuations have recently allowed the sector to recover a portion of its early fourth quarter losses. We estimate that as of November 3rd, our book value has declined to a range of $9.07 to $9.45 per share. Despite the extreme volatility, earnings available for distribution remain strong during the quarter, coming in at $1.51 per share. as we continue to benefit from our low-cost hedges as well as very attractive ROEs on new investments. Our debt-to-equity ratio ended the quarter at 6.4 times with substantially all of our $5.4 billion investment portfolio invested in agency mortgages, and we maintained a sizable balance of unreserved cash and unencumbered investments totaling $392 million. Post-quarter end, we responded to elevated interest rate volatility and further pressure on agency mortgage valuations by actively reducing the size of our portfolio, bringing our debt-to-equity ratio down to approximately 4.3 times at the end of October. This reduction in risk will impact our earnings power commensurate with our reduction in assets. We remain cautious on the near-term outlook for the sector, given the uncertain types of fiscal and monetary policy and heightened geopolitical risks. However, the potential reduction in interest rate volatility associated with the eventual normalization of monetary policy should be supportive of our target assets. Agency mortgage supply and demand dynamics are expected to improve in the coming quarters as loan originations remain low in the case of elevated interest rates and seasonal factors. Commercial banks should also soon receive greater clarity on the regulatory requirements which could encourage further deployment of capital away from loans and into lower risk-weighted assets such as agency mortgages. Finally, valuations and production coupon agency mortgages remain historically attractive, and funding capacity is robust. While we remain cautious in the near term due to elevated volatility, we believe over time the decline in interest rate volatility in a supportive technical environment combined with compelling valuations and favorable funding conditions should create attractive agency mortgage investment opportunities for long-term investors. I'll stop here, and Brian will go through the portfolio.

Thanks, John. Good morning to everyone listening to the call. I'll begin on slide four, which provides an overview of the interest rate and agency mortgage markets here today. As John mentioned and is shown on the chart in the upper left, yields on longer-maturity U.S. Treasuries rose sharply in the third quarter in a bear-flattening move. Short-term rates rose modestly, as the slowdown in inflation data signaled an impending pause in monetary policy tightening, while yields on Treasuries maturing between 5 and 30 years increased between 45 and 85 basis points, as investors priced the risk that a resilient economy and substantial Treasury issuance would impact the longer-term path of rates. By the end of the third quarter, pricing in the Fed Funds futures market reflected a higher-for-longer stance by the Federal Reserve, pushing expectations for cuts into the second half of 2024. These trends intensified into October as interest rates and interest rate volatility moved higher post-quarter end. As shown in the lower right chart, U.S. commercial banks further reduced their holdings of agency RMBS during the quarter, concurrent with runoff of the Federal Reserve's balance sheet, resulting in increased reliance on money manager and overseas investment to support agency RMBS valuations. While overseas investment in the asset class has been robust in recent months, mutual fund outflows dampened demand from a money manager community that was already overweight the sector with little room to add exposure. In addition, organic net supply of agency mortgages to the market increased during the quarter as housing seasonal strengthened, while the remaining specified pools held by the FDIC were liquidated by the end of the quarter. Taken together, supply and demand technicals worsened during the quarter, providing a tenuous environment as interest rate volatility increased. Slide five provides more detail on the agency RMBS market. In the upper left chart, we show 30-year current coupon agency RMBS performance versus U.S. Treasury since year end, highlighting the third quarter in gray. Production coupon agency RMBS performed poorly during the quarter as investor expectations for monetary and fiscal policy fluctuated, leading to sharply higher interest rate volatility. Current coupon valuations end of the quarter significantly lower versus treasuries, and agency RMBS spreads widened approximately 20 to 25 basis points across the coupon stack. In addition, specified pool pay-ups continued to decline as interest rates increased, as indicated in the chart on the top right. As shown in the lower right chart, the dollar roll market for TBA securities remained unattractive, as more recent issuance with higher loan balance have a less attractive prepayment profile. and the lack of consistent bank demand negatively impacted technicals. Although agency RMBS underperformed in October, the market did stabilize in the latter part of the month as investor selling dissipated and volatility subsided modestly. Slide six provides detail on our agency RMBS investments and portfolio changes during the quarter. Our portfolio of agency RMBS decreased marginally over the quarter as the combination of higher interest rates and wider spreads led to lower prices on our assets. We remain focused in more attractively priced higher coupons, which are largely insulated from direct exposure to assets held by the FDIC and on the Federal Reserve's balance sheet. In addition, we remain exclusively invested in specified pools with no exposure to the deterioration in the dollar rule market for TBA securities. We continue to modestly improve the quality of our specified pool holdings by increasing our allocation to lower loan balance stories given more attractive valuations during the quarter. Although we anticipate elevated interest rate volatility to persist near term, we believe current valuations on production coupon agency RMES largely price in this risk and represent attractive investment opportunities with current gross ROEs in the mid to high teens. Our remaining credit investments are detailed alongside our agency CMO allocation on slide seven. Our credit allocation declined during the quarter to $34 million due to pay downs. Our credit allocation remains high quality with 83% rated AA or higher. Our allocation to agency interest-only securities detailed on the right side of slide 7 remained unchanged, totaling $78 million at quarter end. Although we anticipate limited near-term price appreciation in our credit and agency I.O. investments, We believe these assets are attractive, unlevered holdings that provide favorable yields. Slide 8 details our funding and hedge book at quarter end. Repurchase agreements collateralized by agency RMBS remained at $5 billion, and our weighted average repo cost increased to 5.4%, consistent with changes in short-term funding rates due to tightening monetary policy. Repo spreads were relatively steady during the quarter, and counterparty appetite remained strong. Positively, we we increased the hedges associated with those borrowings to $5 billion net notional of current pay fixed received floating interest rate swaps, increasing our hedge notional to 99% of borrowings and mitigating the impact of higher borrowing rates on the earnings tower of the company during the quarter. Our economic leverage ended the quarter modestly higher at 6.4 times debt to equity versus 5.9 times at the end of June, mostly reflecting the decline in book value over the quarter. Positively, our liquidity position at quarter end remained robust, with $392 million of cash and uncovered investments representing approximately 7% of our investment portfolio. Slide 9 provides further detail on our interest rate swap portfolio. At the end of the third quarter, we held $5.9 billion notional of low-cost pay-thick swaps and $950 million notional of receipt-thick swaps. Given the significant challenges presented during the quarter, we modestly repositioned the hedge book to extend the weighted average maturity of our pay fix swaps and reduce the maturity of our receive fix swaps. Because the tenor of our low-cost pay fix swaps was over seven and a half years, we were largely able to avoid adding new pay fix swaps at higher rates as the durations on our agency RMVF extended into the most recent sell-off, with our average pay fix rate increasing from 0.45% to 0.79%. quarter over quarter. Slide 10 provides an update on our asset and hedge portfolios as of October 31st, which should offer a helpful picture of the changes we made post-quarter end. Since the end of the third quarter, we aggressively reduced leverage as elevated interest rate volatility led to sharp declines in our agency RMVF's valuations. As a result, our debt to equity leverage declined from 6.4 times to 4.3 times in October. Liquidity remained robust as our cash and unencumbered investments increased to $444 million. As you can see in the top left chart, we remain allocated to higher coupon agency RMES, and our specified pool allocation is now of higher quality, with nearly 50% of our holdings in loan balance collateral. In addition, we also reduced the size of our hedge book commensurate with the reduction in our assets, with our pay fixed swap hedges declining from $5.9 billion at quarter ends to 3.9 billion at the end of October. Positively, our average pay fixed rate declined marginally from 0.79% to 0.76%, and the weighted average maturity of our hedges is now 8.6 years, providing support for the earnings power of the company. To conclude our prepared remarks, the third quarter of 2023 was yet another very challenging quarter for agency RMBS investors, as interest rate volatility increased sharply once again. We believe our bias for more attractively priced higher-coupon specified pools leaves us well-positioned in the near term, given the potential for a further decline in interest rate volatility as the Federal Reserve seeks to conclude monetary policy tightening. Further, our liquidity position is robust, as leverage remains well below historical averages for an HCR and BS-focused strategy. As a result, IVR is well-positioned to navigate future mortgage market volatility and selectively capitalize on historically wide agency RMBS spreads. While we anticipate potential near-term volatility as monetary policy tightening concludes, we believe current valuations provide a supportive backdrop for the long-term investment. Thank you for your continued support for Invesco Mortgage Capital, and now we will open the line for Q&A.

The phone lines are now open for questions. If you would like to ask a question over the phone, please press star 1 and record your name. To withdraw your question, press star 2. The first question in the queue is from Trevor Cranston with JMP Securities. Your line is open.

Hey, thanks. Good morning. I think you guys took leverage down to a, I guess, pretty conservative level as of the end of October. Can you talk about if that level is one you're comfortable staying at for the near term and Given the negative earnings impact of the asset sales you mentioned, can you maybe talk a little bit about how you're thinking about the dividend in that context? Thanks.

Yeah. Hey, Trevor. It's Brian. Good morning. And I'll start with the leverage comment or turning it over to John for the dividend. Leverage, yes, is certainly well below kind of our longer-term average here as an agency mortgage-only REIT. You know, we do think that, you know, given the level of volatility currently in the market, that a conservative approach is warranted. And so, you know, while, you know, probably, you know, if we were to be in a, you know, mostly lower interest rate ball environment, leverage would probably look a little closer to where we were at the end of June. Given where we are right now, you know, we think a more conservative approach is warranted.

Yeah, and hi, Trevor. It's John. I mentioned the dividend. Yeah, so, I mean, first of all, the dividend is determined by our board, and, you know, I can't comment directly on future action. This will be determined late next month. But I can say, you know, the earnings power has declined along with our leverage, but, you know, keep in mind that EAD has been covering the dividend by a fairly significant margin in recent quarters. You know, and then, you know, there are several factors that we consider when setting the dividend. Among them, EAD, obviously, one of them, along with historical and prospective return profile of our target assets, and then dividend yields available in the sector. So, I mean, there's a bunch that goes into it. It's like, you know, but that will be determined later by our board.

Okay. Okay. Thank you.

And the next question in the queue is from Matthew Erdner with Jones Trading. Your line is open.

Hey, good morning, guys. Thanks for taking the question. So you mentioned part of the portfolio kind of going to the lower loan balance production coupon. I believe at the end of the quarter, the distribution amongst coupons was pretty balanced. So going forward, should we expect a higher percentage of the portfolio to be concentrated in those new production and higher coupons?

Yes, Matt. Hey, it's Brian. Good morning. Yes. You know, it's likely that as we move forward here, we would look to add in higher coupons. You know, you'll notice on the October 31 slide that we did add a modest amount of 6% coupon, which was, you know, in addition relative to where we had been on the coupon stack. So I think that's a pretty good estimate of where new purchases would occur going forward. Got it. Thank you.

And I'm showing no further questions at this time.

Okay. Well, I'd like to thank everybody for joining us on the call and we look forward to speaking, I guess, in February. Thanks. Thank you.

This concludes today's call. Thank you for your participation. You may disconnect at this time.