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Invesco Mortgage Capital (NYSE:IVR)

14th Annual Credit Suisse Financial Services Forum

February 13, 2013 10:15 AM ET

Executives

Rich King – President and CEO

Analysts

Doug Harter – Credit Suisse

Doug Harter – Credit Suisse

Thank you for joining us. We're happy to have Invesco Mortgage back at the financials conference with us. From IVR today we have CEO Rich King; CFO Don Ramon and the Chief Investment Officer, John Anzalone. I'll turn it over to Rich for a few opening remarks about IVR and sort of how they are positioned today and then we'll leave some Q&A up here. With that, turn it over to Rich.

Rich King

First of all good morning everybody. Apologies for a slight delay and really appreciate everybody's interest in Invesco Mortgage Capital and I want to thank Doug and Credit Suisse for hosting us. Just broadly, we really like the environment that we're seeing today for Invesco Mortgage Capital because, we have somewhat less than 50% of our equity invested in the agency mortgage space and a little over 50% invested in the credit space. On the agency side, the wins that are back here because we've seen with a little back up in rates and a little backup in spreads as well. We're back to levels where the ROEs, IRRs, look pretty good and the agency space and since the raise, we've actually, we've put on a little bit more interest rate protection than we did asset duration. So, I think we're well positioned from that standpoint. And the agency space as well, we're also seeing repo levels improve for us. So a little help there. Prepayment speeds slow a little bit. So a little bit of help there as well.

So with prepays and repo we think things improve a bit from that standpoint. We've really focused on interest rate protection, putting on our swaps in the tenure space, protect from any potential extension. Should rates go up more than say forwards or more than we think they will?

So we feel like we're in a good place there. And then the other, the big picture thing is what we can do on the credit side. So one we have Invesco real estate and we're working with them. We have a plan to put on a pretty good size in CRE loans this year. And with a view to hold those that potentially could securitize down the road and then on the resi space, we're looking for opportunities from the government to risk sharing pilot transactions and potentially securitization. So we're getting our house in order to be able to hold loans, certainly we can do bulk trades and hold subs.

So we have a lot of opportunity but the big deal is really I think on that front, I mean for anybody in this space is being in a place to take advantage of what's coming because the government is going to reduce their rolling housing market. They are going to shrink their percentage of loans that are better guaranteed and then on loans that are guaranteed, they are absolutely planning to sell of that credit risk. And so, the capital that we've raised has a view to take advantage of that and the nice thing with IVR is we have the ability to take advantage of that in the long run but still earn a pretty nice dividend in the meantime and we do think that there is some room for our asset spread tightening which can give us a little lift as well this year. I think that’s all I want to say upfront and sit down and let Doug take over here.

Doug Harter – Credit Suisse

So obviously you guys just completed a capital raise about a week or so ago. Can you talk about what kind of led you to the decision to raise that capital right now?

Rich King

So, really some of the things I just spoke about, we saw rates back up, we saw agency spreads widen. We've seen repo fencing levels lower by about 10 basis points from where they were in December and prepaid speeds slowing. So, the IRRs that we can put on with new capital were attractive relative to some of the IRRs we have in the portfolio. So we can do something that was accretive to earnings. That was about flat to book value. And puts us in a better position going forward.

Doug Harter – Credit Suisse

And just along those lines, in 2012 your goals were to sort of increase book value and sort of promote stability of the dividend. What's your view right now on that stability of the dividend as we go into 2013?

Rich King

We think that the level we've, I think we've paid for six quarters in a row, $0.65 is sustainable. I think a lot of people look at some of our earnings, we've been earning more than that, but some of that has been gains. We've been able to do that in the context of growing book value and really and look at it as value added in terms of portfolio reallocation and we're able to sell agency securities at a gain, put it in credit where we think we have as good of a yield opportunity but a better upside in terms of book value opportunity.

Unidentified Company Representative

Yes, I would just add, when you look at it from the standpoint of the assets that we've added since quarter end and so forth. We really think that it puts us in a very good position to protect that position. And again, if prepayment speeds slow down, if you see some decline in repo rate and so forth, you could actually have some potential that those core earnings could actually increase over the year as we go through. So, again, we think we're in really good position to protect that for the year. Again, you're going to have to see how things go.

Doug Harter – Credit Suisse

(Inaudible) referenced couple of times around repo rates falling. Can you just put some numbers around that, how, is it likely to sort of stay at current declined levels?

Unidentified Company Representative

Yes, I think at yearend we're probably high 40s in terms of repo rates including the term for day to day repo and we've seen that steadily decline. We're probably in the mid to high 30s right now and really I think it's hard to predict where they are going to go near term but certainly that trend has been that they’ve been lower. So we wouldn’t be surprised to see that continue. Not that long ago, they were in the kind of high 20s area. So, nothing's really changed all that much in terms of the environment in terms of four repos.

And it's one of those things where Rich alluded to, we think there are some possible sort of tailwinds in the agency side in terms of selling prepaid, the potential for repo to improve and it spreads tightening.

Doug Harter – Credit Suisse

Can you just talk about repo on the credit side, what have you seen there in terms of price, availability, haircuts?

Unidentified Company Representative

Yes, in fact, it's interesting. On the credit side, we've actually seen probably slightly better demand or a better supply from banks that our repo providers have been more willing to lend on credit. So that’s been good so the supply has been very good there. Our terms have been fairly steady I would say. I think it hasn’t really moved all that much in the past few quarters.

Rich King

What we have seen on that is I think a view from our counterparties that I believe they think that rates are going lower for a credit repo. I mean because you have fundamentals improving and at the same time, so, what we're seeing is people wanting to do term financing like committed facilities and things like that. So, we've seen improvement from that standpoint but just from the straight 30 day rate, it really has been stable.

Doug Harter – Credit Suisse

You’ve now referenced couple of times about the potential for prepaids to slow. Does that change how you think about asset selection on the agency side? Would you still prefer the specified pools?

Rich King

Yes, I think the way we view it, we're big proponents of (inaudible) obviously, given our history but no, it's still very good. I think buying pools of a better complexity profile is going to be important. I mean obviously the types of pools we have been purchasing has changed pretty dramatically from over the last three years. I would expect that to continue. I think as we get into a higher, if rates do start to rise, there is definitely going to be different types of assets we're going to want to purchase. But I think from our perspective, I think specified pools still are really attractive in terms of buying an asset that you can actually finance for a longer period of time and be confident in cash flows and things like that. So we're pretty positive on that.

Doug Harter – Credit Suisse

Can you talk about how you're hedging those for the rest of those premiums or perhaps on a specified pools in the event that rates rise and how that would differ versus beyond more generic collateral?

Rich King

It's easier to hedge because you have an asset that’s already paying relatively slowly. So it’s a longer cash flow and so, as I said, we've been using longer swaps to hedge longer cash flows. And if you buy TVAs, and you have something that either you buy something that’s paying kind of fast and can slowdown a lot and extend the duration on rates rise or you buy something that’s actually pretty long like a low current coupon bond and when rates drop and you have a prepay protection in the form of oil and (inaudible) or something. So that’s a hard cash flow to hedge in (inaudible). So, that’s part of why it was like specified stories. I mean we think they carry better, but we also can hedge them more specifically.

Doug Harter – Credit Suisse

And I guess just shifting to the non-agency space. Moving a little bit more to the credit sensitive versus where you’ve been higher up in credit. I guess talk a little bit about why now obviously those bonds have moved, what you still see there, what types of yields return on equity if you can still get in that space.

Unidentified Company Representative

Not into space. We had shifted a little bit of our focus in terms of what we're buying. So if you listen to our story over the last few quarters, it's been more focused on the senior (inaudible) side which are obviously better protected from a credit side, but you do lose potential upside in housing recovery. I mean there is much more stable bonds. So as we've seen improvements in housing start to pick up, we wanted to make a shift more towards legacy bonds that have more of a exposure to an upside in housing. So that’s kind of where we've been focusing new purchases. So in terms of available yields, I mean we're probably looking at loss adjusted unlevered in the 4 percentish range, 4 to 4.5% depending on your assumption, it's in that range. We're still towards the top of the capital stacks, so we're still not buying some primary option arms. We're still more traditional ball pay and prime time bonds. They are still financed very well, probably with our prices; probably average is kind of in the 80s, in that realm. So, we still feel comfortable with the ROE profile and given very comfortable with the leverage we're putting on that.

Doug Harter – Credit Suisse

And how would you characterize what types of assumptions to get to those loss adjusted deals. Is there still room for upside if housing continues to improve and I guess how do you kind of frame that potential for upside if housing improves/

Rich King

One of the biggest drivers in the model is the LTV in the current combined loan to value and so, to the extent you have loans in the pool that let`s say, there are 110 loan to value and you get appreciation in housing. You already have some benefit in there somebody who has been making their payment for a number of years underwater is not likely to default but you get a lot of benefit and lower default assumptions if you get house price appreciation and that’s where a lot of the upside comes in. And you also will have more prepayments which this returns as well.

So, we're seeing in terms of improved severity as well. And when there is a default, the short sales, basically are picking up in terms of percentage of relative to foreclosure sales and so forth. And the severities are much, much smaller on short sales and so, really in modeling, we tend to be somewhat conservative in terms of what we expect in terms of delinquency and severity and prepayment and when you get a kind of a virtuous cycle in housing where house prices start going up, people feel better about buying a house because they are not afraid it's going to fall, and then because house prices are going up, credits start to become more available, securitization picks up, just overall credit environment improves, that’s going to cost us right if we go up more so the upside comes in all the different places in the model.

Doug Harter – Credit Suisse

If I recall one of the things you had talked about in the past about one of the challenges with remote credit, sensitive bonds or service or behavior, I guess sort of how are you viewing that today, and sort of how you get sort of comfortable with that part of the modeling.

Unidentified Company Representative

Yes, intrusive, I think that's still true, you'll notice we are still not as comfortable with sort of like the auction in our market and the supply market because that's one of the big reason why because your timing of your cash flow really, really matters since we are very, very sensitive to those assumption in terms of how a servicer handles that process. So I think that's probably been the number one reason that we are not involved in those. Because it's hard to predict, it makes it harder to hedge, it makes it the cash flow profile of those tax bonds is just harder first us to get arms around in terms of timing of cash flows, which makes hedging harder and things like that. So (inaudible) basically what we've have seen.

Rich King

Yes, I think that market's definitely around the most, when we look at model outputs, we just tend to get about the same type loss adjusted yields and cleaner stuff that we can predict better and finance better. And that's why we have learned just under current space.

Doug Harter – Credit Suisse

Okay. And I guess just shifting to CMBS. Where in CMBS are you finding the most attractive opportunities right now?

Unidentified Company Representative

Yes, on the CMBS bond side, we are still, these three spot we found is come from a single A cash flow , we think that's, that's been the place where we're finding best risk adjusted returns, so I think that's we are continuing there. I mean obviously from deal to deal, it can change sometimes it will play BBB even a little bit better than single A. I mean that's been generally where we found the best risk adjusting returns. We're starting again as in housing I think we are starting to see still slowly improving fundamentals. So we've been comfortable taking that risk at that level. It's kind of nice area, and we think that's a bit of a sweet spot we've seen even spun away from fundamentals on the technical side also we think that it is a nice place to play in terms of, there is enough investors looking for yield that we know we've seen bond prices supporting just from that also. It's been good.

Doug Harter – Credit Suisse

I guess also in Rich's prepared comments he referenced some commercial real estate mix loan to making, I guess just talk about those new loans, legacy loans kind of what you see attractive in that space.

Rich King

Yes, we are looking at new loans Invesco real estate has acquisition people and all over the country, all over the globe actually but we are focused in the US. And really we are just looking for strong cash flow properties that we can get, call it in the 8% to 9% unlevered and it's just become a focus this year. So we have a goal to put on about $300 to $400 million.

Doug Harter – Credit Suisse

How is that type loan finance and sort of what type of levered returns can you get if you get 8 to 9 unlevered?

Rich King

Yes, we can put warehouse in place and those best returns in to double digit certainly. I think we'll look at other opportunities to potentially may be issue different types of things others than common equity in the balance sheet as well to finance this type of asset, and kind of this returns.

Doug Harter – Credit Suisse

And then just sort of other areas of new investment opportunities, you talked a little bit about the growth of non-agency loans. Are you guys looking at doing securitizations, if so, would you setup your own conduits. What are the sort of advantages cost of having your own conduit versus just buying that credit pieces of a deal.

Rich King

Where we are in regulation, we're really happy with the fact that we have QM. QRM is coming, we don't know when. So there is still that kind of question. And then setting up a shop is actually kind of difficult in a long timeframe to do, so our view would be it makes more sense now to rent a shop than it is to create our own shop. Now in the long run that might change, but that just makes the most sense today, there is talk of the government setting up the new securitization infrastructure. So it doesn't make a lot of sense to up and do that right now. So yes, we'd be thinking of rent a shop.

Unidentified Company Representative

Yes. We certainly have been already in a preparation stage. It will just take a while to set up, do those things. And we've also just like several others have been offered opportunities for all long packages and securitize and so forth. Again you could probably see us doing that, but it is just looking for those opportunities when they come along.

Doug Harter – Credit Suisse

How would you compare the returns, the risks of that type of a loan securitization today versus the other opportunities you see?

Rich King

Yes. The big deal about securitization is what's going to happen not what's happening today. So there is really not, it is not like there are high returns available buying loans and securitizing them now. But what's happening is that you can see that it's going to be there. And so you have to get in a position to be able to do that. We want to be a company that provides private capital to the market place, and mortgage finance 2.0 we see that there is going to be, as I said, a larger percentage of loans made that are private label in the future. And the government is going to sell first loss credit risk. So if you think about that and the spot trillion of agencies out there assumes 7.5% first loss fees, the numbers are big. I mean somewhere $250 billion to $500 billion of private capital needed to lock, plus the private label securitization market. So the returns are going to be there. I mean that's clear. The issue is today we can still generate a better ROE buying legacy bonds and financing them, and doing CRE in the agency side. So the point is we have the right organization to setup to do what we need to do, both in the securitization of resi and commercial, and I think we have been well served to do, we have done so far in that. We have earned higher yields than if we had three years ago gone out and set up a securitization we've seen because they are just the loan volumes is still isn't there today.

Doug Harter – Credit Suisse

Do you need to be early to that to be able to capture the coming volume, or I guess so how do you sort of make that trade off getting ready for the potential opportunity may be a little early versus being late, hindrance to being late.

Rich King

I think we are still early. I mean we are seeing some pickup and bulk on sales and some pickup inflow, but we still don't have wholesale big increases and loan origination. And I think you need to have that to make the economics much better. So I don't see and when the flow does pickup I think I just like early 2000, there are plenty of waste get involved when the action is there.

Doug Harter – Credit Suisse

Just on that first last piece, is there any sense in timing just a way when we might sort of see progress on the GAC, it has been talked about for a while. When we might actually see an actual first trade in that.

Unidentified Company Representative

I think our part is that they don't happen this year, it is hard to, obviously it is hard exactly to time it but there is absolutely looking at different ways of structuring those first lost pieces, so conversations we have had, the government absolutely getting ready for it right now. So it is a matter of hammering out details in terms of, our part is good, there is likely to be several flavors of it to come out. I mean in terms how they actually sell those pieces. So that's taking a little bit of time. Ramon, if you any?

Rich King

Yes. We did expect casino subordinated structure and then no structure; we have been embedded risk going from here.

Doug Harter – Credit Suisse

Okay. I guess just one last one for me, and then we will open to the questions from the audience. What is your appetite or interest in acquired MSRs, obviously over lack as a nice hedge from a book value interest rate perspective? How do you view those returns, and the challenges of that business?

Rich King

It is an interesting market and there are opportunities there, but they are kind of few and far between. We have worked with audio 4 (inaudible) 2.03 his team, he sold, off they sold Home mart to Auckland in December, and so the issues to really be able to take advantage of that, you really need an originator so that, because if you just go out and buy MSRs, and your subject to churn where are I am in the line of interest, so when you have originator you can kind of recapture some of the loss from prepayment, so there is just not a ton of volume of sales, there is going to be few huge scale sale, but we are just still far anyway. We are just not seeing a lot of volume.

Doug Harter – Credit Suisse

Does that, do you think that changes or do you think it is just see the large scale trade?

Rich King

It's hard to say. It seems like; I mean so far it is just large sale so that it could continue. We definitely beating the bushes to find opportunities but they are just not there.

Doug Harter – Credit Suisse

Great. With that open up, Johnny, any questions here from the audience?

Unidentified Company Representative

Well, thank you all for joining us today.

Rich King

Appreciate, thanks everybody.

Question-and-Answer Session

[No Q&A session for this event]

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