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Invesco Mortgage Capital Inc. (NYSE:IVR)

Q2 2013 Results Earnings Call

August 1, 2013 8:30 AM ET

Executives

Richard King - Chief Executive Officer

John Anzalone - Chief Investment Officer

Don Ramon - Chief Financial Officer

Analysts

Douglas Harter - Credit Suisse

Trevor Cranston - JMP Securities

Mark DeVries - Barclays Capital

Cheryl Pate - Morgan Stanley

Mike Widener - KBW

Joel Houck - Wells Fargo

Daniel Furtado - Jefferies

Operator

This presentation and comments made in this associated conference call today may include forward looking statements. Words such believe, expects, anticipates, intends, plans, estimates, projects, forecasts and future or conditional verbs such as will, may, could, should and would as well as any other statements that necessarily depends on future events are intended to identify forward-looking statements.

Forward-looking statements are not guarantees and they involve risks, uncertainties and assumptions. There can be no assurance that actual results will not differ materially from our expectations. We caution investors not to rely unduly on any forward-looking statements and urge you to carefully consider the risks identified under the captions, Risk Factors, Forward-Looking Statements and Management Discussion and Analysis of Financial Conditions and Results of Operations in our annual reports on Form 10-K and quarterly reports on Form 10-Q, which are available on Securities and Exchange Commission’s website at www.sec.gov.

All written or oral forward-looking statements that we make or that are attributable to us are expressly qualified by this cautionary notice. We expressly disclaim any obligation to update the information in any public disclosure if any forward-looking statement later turns out to be inaccurate.

Good morning, ladies and gentlemen. Welcome to the Invesco Mortgage Capital Inc’s Investor Conference Call. (Operator instructions) Now, I would like to turn the call over to the speakers for today, Richard King, Chief Executive Officer; Mr. John Anzalone, Chief Investment Officer; and Mr. Don Ramon, Chief Financial Officer. Mr. King you may begin.

Richard King

Thank you. Good morning everybody and as always thank you for dialing in. I plan to first review the second quarter environment and our results and then talk about what we’re doing going forward including the strategy for hedging and leverage and of course our asset strategy. And then, John Anzalone our CIO will talk before we open up for questions.

The second quarter was challenging and surprising in some respects in that. Rates rose rather dramatically even as the economic growths remained quite lackluster. The unemployment rate at 7.6 is still well above the said 6.5% threshold for removing accommodation and core inflation at 0.8 annualized over the last three months has actually fallen further below the said threshold with rates covering near historic lows in the said repressing yields. Investment flows out of bonds into stocks were to be expected however. Given this environment, we expected rates to increase this year and we increased hedges accordingly. I’m not saying we were expecting 100 basis point horizon in the tenure in less than two month, because we continue to see an economy is growing only modestly and that policy that’s likely to remain accommodated even when the economy gain strength.

But our understanding of the environment encourage us to take a number of action to reduce rate risk in the first quarter, namely increasing the amount of and lengthening the term of interest rate swap hedges, adding hedges in the form of swaption, issuing fixed rate exchangeable notes and reducing our repo leverage. All of those actions did benefit our shareholders in Q2.

We also took further actions throughout Q2 that helped namely adding more paired swaptions and reducing agency MBS holdings. In fact, when we look at the attribution of the factors, it cause roughly 12.5% drop in our fair market value. We can see that the actions we took were very helpful. Because of those steps, the rise in the level of interest rate and the steepening of the yield curve did not cause the majority of the book value decline.

In fact, by far most of the decline was result of widening in credit spreads across the mortgage market, not only in the agency mortgage market but also in non-agency MBS and CMBS. Those are really the factors that cause book value to decline primarily and unlike rates, we see the spread widening as an aberration not as trend.

As mortgage REIT, we had interest rate risk. We expect mortgage credit risk that we’ve underwritten. We generally except mortgage spread risk as well and to that point, over the last year, rates are higher by about 80 to 85 basis points whether you look at five swap rates or tenure treasury, and IVR’s economic return, that is the dividend plus change in our book value is up about 11.5%.

So given that rates are up, more than -- most investors would have thought with prepaid fees much faster than we likely see going forward. The knowledge that we generated that type of return on book value should indicate that we can generate attractive return in an up rate environment going forward.

We’re pleased that spreads are become more attractive for the redeployment of our cash flow going forward. So the good news here is we are hybrid mortgage REIT, whose high-level strategy is to generate an attractive dividend, primarily via earnings high-quality asset with attractive credit spreads. We’ve especially signed attractive those assets with predictable cash flows that we can hedge effectively.

We are not generating the divided primarily by accepting interest rate risk and again, because rates are still very low and it’s reasonable to expect that, a trend towards higher rates to be persistent.

We expect that the credit spread dislocation in Q2 that was not likely to persist. We find credit spreads in the mortgage space very attractive and supportive of our fair market value.

What we saw in Q2 was more of a major reaction where mutual fund manager of course surprised with outflows. They had to sell credit assets in the quarter end. And in addition, they were convexity related selling out of our industry to reduce interest rate risk as rates went up and mortgage bonds lengthen it average life. This coincided with dealers also trying to release assets in the quarter end.

Now let me say a few words about earnings. In the second quarter GAAP earnings were very high despite our core earnings remaining stable at close to $0.60. The dollars REIT GAAP earnings per share easily supported the $0.65 dividend, partly due to $0.39 of increase in the value of swaption. We also took gains in the second quarter by selling agency MBS which we believe were expose to extension of HARP cut-off date.

While we are pleased with the $3 of earnings, we want investors to realize we have taken some losses in the early Q3 and the swaption positions are growing to increase earnings volatility. While there are hedges if change in the value of swaptions close directly to our earnings unlike interest rate swaps.

So what is all this means for IVR going forward. Our goal to this year has been to transition the company to a lower interest rate risk strategy and to reduce agency MBS and save our mortgage credit assets. We favor securitizing mortgage loans and retaining the subordinate vision to gain financing and to invest in commercial real estate mezzanine loans. All of these actions will reduced repo borrowing and position us for the future. Our goals remain the same, we expect that as credit spreads recover, our book value will improve and you should see our repo leverage decline as well. In the meantime, over the period of higher volatility and we therefore will hold down repo leverage and interest rates gets primarily into a first – we didn’t reinvest our cash flow into agency MBS in the second quarter and that’s part of why our balance has declined.

And rather we’re holding additional cash and unencumbered assets as a cushion. We also added the swaps and swaptions through the interest rate duration of our equity. Due to these actions, we’re currently seeing core earning somewhat lower early in Q3 versus Q2. And while we may see our net interest margin improve because of slower prepaid speeds and better reinvestment yields that does take some times to play out. We think everything we’re doing in this environment is prudent and in the best interest of our shareholders and because of these actions we’re very bullish on future of investor mortgage capital.

We believe we can grow book value, reduced repo leverage and generate attractive dividend, we see plenty of opportunity for Investor Mortgage Capital with this not entail taking on due interest rate risk.

And IVR is an important – is an investment in an industry where we see a lot of opportunity for a number of years in the mortgage industry. We remain very excited about playing the meaningful role and rebuilding in the U.S. mortgage market.

And John Anzalone will now discuss our investment strategy and portfolio in more detail.

John M. Anzalone

Thank you, Rich, and thanks again to everyone joining us on the call this morning. I’ll go through our current portfolio positioning and some of the steps we took during the quarter and how we were set up for each year.

I’ll start on slide four to that with that the portfolio update. As you can see on the chart of my left of the slide, we continue to evolve the portfolio during the quarter. We completed three securitizations during the quarter, which added $1.1 billion in consolidated range. Total MBS portfolio declined about 7% to just under 20 billion. And this is due to a combination of asset sales, pay downs and price declines.

This note we’re concentrated on the agency side, as early in the quarter, we said approximately $240 million full that would be at risk to higher pre-payment, as the hard program is extended by one year. Later in the quarter, we said an additional $950 million in order to maintain our leverage and duration in that discipline.

We also continued to add credit assets as our non-agency growth increased by $195 million and our CMBS growth increased by $149 million. Finally, we added about $9 million in commercial real estate loans, which is part of a larger $40 million commitment.

Moving to slide five. We ended of the quarter, with our overall leverage at 7.6 times, which dropped to 7.1 when we back out the impact of unsettled trades. This is an increase in last year’s figure of 6.4 times, and this increase is due to lower equity level, credit asset purchases as well as the additional residential loan securitizations.

As we talked about on last quarter’s call, we are more focused on reducing the leverages that is associated with repo, as opposed to the structural leverage associated with securitizations. Our repo leverage ended the quarter at 6.1 times.

I’m moving to slide 6 in our interest rate hedges. As you can see the chart at the top of the slide, we were fairly active in adding interest rates hedges during the quarter. As we are disciplined in keeping our durations that was in our target range of 1 to 1.5 years. We added $1.85 billion in interest rate swaps, all of which were five years or longer. We also ended the quarter with additional $1.4 billion in swaptions positions. It’s important to note that these swaptions were all struck on longer terms swaps, which are having 10 years and most were only 25 to 75 basis points out of the money the time to struck.

It’s got to be important in the recent environment as these positions offer very effective hedges and increase in short term volatility, which we obviously saw a lot of during the quarter. As far as where we stand now, we ended the quarter with 113% of our ABC [ph] repo hedges with swaps and swaptions and 82% of all repo hedges with swaps and swapstions. As such maintaining our discipline in recent quarter has left us in a very good position going forward.

Next, I’ll go through the various buckets of the portfolio starting with agencies on slide seven. As I mentioned, our agency portfolio was down $1.8 billion for the quarter. Agency leverage ended the quarter at 9.6 times. They are taking our unsettled trades into accounts that number was unchanged for the quarter at 9.1 times.

Prepays remain very well behaved with our 30-year book paying at 9.5 CPR for the [third quarter]. Given a sharp back up in rates, you would expect this number to decrease over the coming months.

On a non-agency side, our holdings increased by $195 million as we continue to add legacy in non-agencies. We remain positive on the sector as housing fundamentals were still improving. Technicals remain extremely favorable and these bonds provided a favorable return profile in a rising rate environment.

In CMBS, our holdings increased by $149 million as we continue to focus on adding AAA and AA newer Vintage bonds. As with residential housing, we are positive on the sector as fundamentals are improving and the technical fixtures still remains favorable. Our leverage here increased to 3.9 times due to a combination of low asset prices as well as the focus on higher quality bonds.

I’ll finished with slide 10, residential and commercial loans. It was an active quarter for us in the residential loan stage as we completed three securitizations which added $1.1 billion in consolidated loans for our balance sheet. These served to add $121 million in net credit exposure to our book and participating in these deals provides us with an opportunity to gain exposure to new production prime jumbo mortgages.

On the commercial side, we closed our first mezzanine loans, which is about $42 million commitment. We also purchased approximately $25 million in CRE mezzanine loan pass-through. We continue to view both the loan --loan side of both resi and commercial is really attractable and will continue to explore opportunities in each.

So, with that, I’ll open the floor for questions.

Question-and-Answer Session

Operator

(Operator Instructions) the first question comes from Douglas Harter, Credit Suisse. Please proceed.

Douglas Harter - Credit Suisse

Thanks. John, I was hoping you could update us how the credits -- how credits spread have fared in July?

John Anzalone

Yeah. In July, I would say credit has probably been flat to maybe a little bit tighter. So I think CMBS has done a little bit better. On non-agency positions, I think they are mostly flat up through now.

Douglas Harter - Credit Suisse

Great. And then on the new residential securitizations, can you talk about the impact that higher rates have on the four deals we’ve done so far and then also your outlook for the ability to continue to do more deals there?

Richard King

Hey, Doug. This is Rich. I know, I mean, the beauty there is we gained leverage through selling AAA. So we really don’t have exposure to -- and our financing rates rise were locked in and the subordinates positions, I mean, the credit position that we were getting paid over the life of the deal to excess. So really, there is not a lot of impact from rates on us.

Douglas Harter - Credit Suisse

So Rich, did you retain the IOs on those bonds?

Richard King

Yeah.

Douglas Harter - Credit Suisse

So those should benefit us as rate grows?

Richard King

Right. Yeah, I mean, so you have some duration on the credit services or fixed rate which you have the IO to offset that?

Douglas Harter - Credit Suisse

Got it.

Operator

The next question comes from Trevor Cranston, JMP Securities. Please proceed with your question.

Trevor Cranston - JMP Securities

Hi. Thanks. Just a follow-up on increased allocation towards credit type of assets and assets that aren’t so much leveraged with repo. Could you give us any kind of indication of kind of what your outlook is for the commercial loan opportunities and how much do you think you could potentially originate over the half of the year?

Unidentified Participant

Sure. We don’t – we can’t really give you a forecast because it really, every deal is unique and there is a lot of credit of consolidated obviously. And it is the competitive space. We think over the maximum number of years, obviously there is huge walls of of maturities at the end of the refinanced. And with rates higher, there will be a needs for some (inaudible) financing equivalence.

So we think it’s a big opportunity, but right now, I mean, we’re working on several opportunities, but I need to give a forecast for the likelihood of the size that we’re going to put the work. Anything else, John?

John Anzalone

I think that covers it.

Trevor Cranston - JMP Securities

That’s clear. On the residential side, could you guys comment if you participated in the Freddie Mac credit deal and how you think about that relative to the opportunities that you come most is?

Unidentified Participant

Right. Yeah, absolutely. We did not participate in the Freddie Mac deal. And the main reason is, we can manufacture what we think is a better risk asset as a better yield. The reasoning is that will, A) they didn’t give the granular information that we typically get in terms of the barrower and the actual real estate. So we didn’t have competitive advantage in that deal that we would say in a prime jumbo deal, understanding exactly what collateral we’re guaranteeing that.

And then, in addition to that, the way it was structured, it was quite (inaudible) at the, it wasn’t a first loft [ph]. You had also fix severity and we would rather take actual authorized as opposed to dealing with delinquencies for whatever reason. So all that said, it’s the first of many risk sharing transactions. We could participate in it. It works as far as it’s a eligible read asset. But just from the relative value perspective, we just like the prime jumbo securitization better.

Trevor Cranston - JMP Securities

Got it. And last thing on the swaption portfolio, do you guys have handy, will be average exploration term of swaptions are and what the average strike rate is?

John Anzalone

Yeah, (inaudible) this is John, the average, it’s about 8.4 months on the average of – what it’s going to expire. And then, the average duration of the swap, all of them are struck at 10 years as well as what underlying swap is, all of them are struck at 10 years as well as the underlying swap is.

Trevor Cranston - JMP Securities

And do you have the strike rate on that?

John Anzalone

I don’t have the right in front of me, but it will be in the queue.

Unidentified Analyst

Okay. Perfect, thank you.

Donald Ramon

We can say that – we struck most of them in the 25 to 50-ish out of the money.

Trevor Cranston - JMP Securities

Got it. Okay. Thanks guys.

Operator

The next question comes from Mark DeVries of Barclays Capital, your line is open.

Mark DeVries - Barclays Capital

First just a quick follow-up on the swaptions, given the striker Invesco have always been – is that still an economic form of protections in that, a kind of, it’s fairly out of the money swaptions?

Donald Ramon

Yeah. You’ll see this – I think it’s on the hedging slide, but in terms of that. But there is, we did take off new swaptions during the month, since they got there, they are close to the management as you brought them a little bit further up out of the money. So we’re definitely managing that book.

And actually, we had – we terminated about $1.75 billion during the quarter and so those were basically swap considered new very close to the money that we restruct another 50 basis points out of the money something like that.

Right. So Mark, (inaudible) that also brings up a great point, I mean, it’s important to highlight that. Several of the gains on swaptions were realized during the quarter and then some were unrealized. So again, as we saw those swaps come closer to the money basically just as John mentioned when we realized the gains to lock in that change and then put new ones on, on a go-forward basis.

John Anzalone

Having your point is right, I mean obviously, this swaps that we put on 70, 80 basis points, certain price volatility were cheaper than (inaudible). So they -- they were at the end of the quarter. But we do expect volatility to be higher going forward and it has been so, in reality.

Mark DeVries - Barclays Capital

Yeah. Thanks, John. Next question, did your credit bonds ended having more duration than you might have modeled or was it the weakness you saw in your credit assets mainly just do the widening in spreads?

Richard King

It wasn't more duration than we modeled, I mean like the CMBS primarily right, those were the longer duration credit assets and, it's -- there is no cash flow variability. I mean, therefore what type of assets, so you know what the duration is. It was really clearly spread widening.

And then in the non-agency staff, I mean, you are close to half the books, re-REMICs with various circulations. So there is no question there and then we do have some legacy non-agency but once again, that is not a meaningful duration component.

Mark DeVries - Barclays Capital

Understood. Okay. So last question, I understand you commented that you viewed the spread widening as a little bit more than aberration in the rate that we saw in the quarter. But did you do anything to reposition the agency book, kind of, other than just kind of understand reducing the position to mitigate your risks and spread widening?

John Anzalone

So -- I mean, through the quarter, we did sell primarily lower coupons, lowest coupons, and mortgages. I mean, that was just to keep the duration in the portfolio more stable. So I mean, that will produce interest rate risk obviously. So combining that with the swaptions is how we managed to keep our duration gap kind of stable. So going forward we have less exposure to agencies obviously through the small portfolio.

Richard King

You also, I mean, if you look at kind of the convexity with mortgages having extended obviously there are less extension risks and with the swaption positions and so forth, we have not -- the convexity risk is not very meaningful from here.

Mark DeVries - Barclays Capital

Okay. Got it. Thanks.

Operator

The next question comes from Cheryl Pate, Morgan Stanley. Please proceed with your question.

Cheryl Pate - Morgan Stanley

Hi. Good morning. A question on the non-agency portfolio, I was just wondering if you can give us some color on the credit asset that were added this quarter relative to the portfolio overall, as there is obviously some pricing -- actually on this quarter, but when I look at sort of discounts, the quarter looks like it will increase from up 7% to about 14%. So just any color would be helpful there?

Richard King

Yeah. So we added small amount of non-agencies over the quarter, we needed a couple of $100 million overall. I believe they were little bit further from target than the books that we owned just because we did not -- we didn't have the REMICs which obviously a lot higher in dollar price. So I think that would -- that would obviously be a lower priced bond there.

John Anzalone

We sold this little bit of -- we sold a little bit like high dollar price bonds.

Richard King

Right, the senior re-REMIC, we sold a couple of those then.

Cheryl Pate - Morgan Stanley

Okay. That's fine. Another question, just on …

Richard King

I just wanted to add that adding credit IO…

John Anzalone

Lower the average…

Richard King

…lower the average price. So I think that is what you are seeing there.

Cheryl Pate - Morgan Stanley

Okay. That's helpful. And then just another question in terms of the provisioning this quarter, how should we thinking about that and sort of, what are the assumptions underlying the provisions?

Richard King

Yeah. Sure. The way we look at that is we take a look at the credit pool just like we do any about our credit bonds. We do a loan level detailed analysis that come up with basically estimate what we take (inaudible) may be in the portfolio. So in other words those new securitizations that we put on, we basically estimated what we think to like – like a lot of are kind of backed into that, so that pool right now and that too we came up with just over $600,000 of expected losses on that. I think the way to think about that is, unless something changes dramatically I wouldn’t expect that number to continue to increase and unless again the portfolio characteristic change, we quite know we don’t anticipate that, you’ll probably see with the next quarter since we put one on right at the end of the quarter, you’ll probably see a little bit of increase in that number, but I wouldn’t anticipate a huge increase on a go forward basis unless we add securitizations.

Cheryl Pate - Morgan Stanley

I got it thanks.

Operator

The next question comes from Mike Widener of KBW. Your line is open.

Mike Widener - KBW

Good morning guys. Let me just follow up little more philosophically on the swaps and hedges question. When you guys talked about your swaps and your hedges, you do what pretty much most of the group does and most of those have become accustomed to it in spite of that the hedges is a percent of repo on the agency as far as the portfolio, which I think makes a whole lot more sense when we’re thinking about locking and funding cost but now that hedges are much more of a book value hedge. I just wondering if you’re thinking about hedge has kind of changed it all and as I think you guys indicated there’s certainly an interest rate risk component to the most of the or at least the wide portion of the credit risk side of portfolio and so I guess the question is, is that just broadened away or change it all the way you think about how to hedge and what you would use to hedge and what durations, specifically at what durations you want the curve you need to hedge?

Richard King

Yeah, I mean look at – we look at the portfolio in part and holistically and we have really very robust analytics to look at the duration and spread duration in Q rate buckets and understand where risk is and we put on swaps for that reason and longer tenures because you tend like on a 30 year fixed rates mortgage or CMBS. You have a decent amount of of the curve and so to protect from not only rising rates that curves deepening that’s why we put really all the additional swap and swaptions out in the tenure area. And so we’re managing on a daily basis kind of our overall deterioration of the equity and we report the amount of swap and swaptions relative to the amount of repo, but on a daily basis we’re really managing those (inaudible) durations.

Mike Widener - KBW

Gotcha. It makes sense. On a different topic, I guess you guys have obviously added a lot of hedges which I think it’s prudent course at the same time book value is down. So you haven’t really covered $0.65 of co-earnings power a year and I guess as we think about assets running down sort and sort of leverage maybe drifting lower rather than higher, wondering if you could talk it all about how you think of – about that dividend rate and sustainability to dividend and sort of what your expectations are for – how the relative economics look going forward versus looking back?

Richard King

Sure, yeah, I think just like we talked last quarter on the call, I mean co-earnings were – have been running at let’s take 60 for quite some time and we’ve been saying $0.65, that’s reasonable to think that they’ll definitely come down as you’re seeing to have spin. And given more swaps and swaptions and somewhat reduced balances of course it’ll probably get around a little lower than – than even the 60. So I think it’s reasonable to expect but on the other hand we have generated additional taxable earnings which will need to be distributed. So, I’m not going to give specific earnings or dividend guidance, but I think your point is well taken that core earnings are below the dividend so in the long run it’s likely to come down.

But and then additionally, you have to think about the fact that, the asset yields are up and prepayments are going to come down. So, we really haven’t made that determination yet in terms of what the dividend is going to be this quarter or the rest of the year.

Mike Widener - KBW

All right. Well, thank you. That’s definitely good color though. I appreciate it.

Operator

The next question comes from Joel Houck of Wells Fargo. Please proceed with your question.

Joel Houck - Wells Fargo

Good morning. Just kind of back on the interest rate hedging strategy, you obviously took the hedge ratio up substantially looking at some of your peers, yet you continue raising it slight or you have got to target duration gap of one to one-and-half year range. I guess the question is, what would it take for you guys looking forward to maybe move the hedge ratio back down, if I’m assuming the duration gap here is fairly tight given your well hedge ratio?

Richard King

I mean, what we’ve seen is obviously, since rates went up 70 basis points call it in the quarter, you did have the mortgage portfolio extend in duration, and so adding the additional hedges, it reduced our the duration of the equity. But, we’ve actually still probably preferred it to take that in straight duration, we’ll lower still rather than go the other way. Because, I mean, I think, the point is we want to deliver an attractive dividend, but also an attractive economic return like I said earlier last year was rates up 80, 85 basis points, even though book value is down $0.50 over the last year, still pretty attractive all in return. And I think we can continue to do that.

And the key thing being that when you look at what happened over the last quarter, relatively small part of it 12.5% decline was driven by answer straight. So I think we’re pretty well hedged. We are -- we don’t think we’re over hedged or under hedged in an interest rate sense.

But it was essentially spread widening. So and what we’ve seen since quarter end is the directionality of the mortgage basis has really kind of gone away in the sense that, during the quarter when rates were going up mortgages were underperforming swap hedges pretty consistently, and then when we get some cycles release rally they tightened.

So but what we’ve seen since quarter end is mortgage is kind of, we’ve seen days when rates go up and mortgages outperform, and so they -- I think the dynamic has changed and so we feel like our interest rate hedges are doing what they’re supposed to do and we feel like we have supporting book value because we think spreads are attractive.

Joel Houck - Wells Fargo

I mean, I guess, I get the part if you, your mortgage rate against REIT changes given the actions you’ve taken and made the risk as spread widening is something that impossible ahead, because I was more curious little bit, is it your intention was things kind of settle down to lesser duration gap move back out to the one, one-and-half year range or you’re going to run kind of a tighter or if you will for the foreseeable future just given the uncertainty [amount are being raised], that’s what I was trying to...

Richard King

I think we’d be meeting much more towards running a tighter duration gap than a longer one, given our outlook.

Joel Houck - Wells Fargo

Okay. And then if I could another, maybe kind of strategy or position question, the [90s] you see mark, not surprisingly we found during kind of technical issues at the end of the quarter. And non-Agency tends to be higher quality which at least near term means is more correlated with the agency book. If you guys taught about maybe bring more to it, to kind of the credit element and access kind of non-correlated assets, the agency (inaudible) or is the case where you kind of feel like it gives more of a time technical transitory issues and we just going to kind of part with the non-agency strategy as it is today.

Richard King

Two things. First thing on the bonds we own, we owned on legacy bonds they tend to be, like you said of higher quality, mostly prime all day. Those we start negative marks obviously in the quarter, and I think some of that as to do a bit. Those are out of the non-agency space that probably the most liquid bonds, so when they were selling pressures those got you affected obviously.

So the preference there is, not to go by your sub claim or option ARMs. I think, if we are going to go down in credit, what we’re trying to do is, go down in credit is a new issue space and the best sort of this added securitization. But in that part of the idea of participating in this securitization is to be able to take and to play into what we feel of our competitive advantage which is doing more granular credit work. And I think that’s the new issue securitization space and buying the (inaudible) really lends itself to their strengths.

So I think that’s where we’re going to see and try to add more like the sort of deeper dies of credit.

Unidentified Participant

And I think from what we saw in the market, in the quarter, sub-prime, wouldn’t have helped, it would have been worst. We saw prices sub-prime bonds down more than the types of bonds we have. So I mean, it was just – over the quarter spread wide, it wasn’t necessarily the durations of those positions as much till we did have (inaudible)

Joel Houck - Wells Fargo

Okay. All right. Thanks. Thanks for the answers.

Operator

Our next question comes from (inaudible) FBR. Please proceed with your questions.

Unidentified Analyst

Hi, thanks and good morning everyone. I was wondering – I understand you can’t really size the commercial loan opportunity at the moment, but can we talk about your capabilities in terms of staff, how many people are doing credit, are you working with other partners who originally first mortgages and your partnering to take the subordinate -- can you just give us a little bit more detail as to how you envision, maybe that strategy working out suppose to just to your size?

Richard King

Yeah. Absolutely. We have commercial real estate team with several hundred people who we partner with on the commercial real estate side in addition to our credit team on a daily basis that kind of leveraging the strength of that commercial real estate team. And it’s a great arrangement because, we have the capability. There are no additional cost to invest the mortgage capital, that’s just all within Invesco.

So we have a tone of capability, we see a lot of in terms of deal flow from our commercial real estate brokers and so forth. So I think it’s just a matter of having the right opportunities come along and the right sizes and we’re focused on quality real estate and anything else John?

John Anzalone

I think that’s, I have to point those of having access to deal flow and getting – having the right relationships within the larger investor in terms of what that brings is really important. I mean, that’s a competitive advantage because obviously I think given the size of most recent – I mean, we have a lot of resources that are disposal that we don’t necessarily need to, but like they work for us, they don’t -- they are just part of investors, so we can have them more we need them.

Richard King

Of course, we don’t, they are just part of Invesco, so we can tap them when we need them, we can use their expertise as needed, that’s really important.

Unidentified Analyst

Okay. Thanks. And I have one more, you just kind of addressing or going back towards, Doug, as well as staffing initially on interest rate and securitization? Can you talk about how you think maybe the higher interest rate environment that we are currently in? Is that creating any dislocation in the new securitization market for new prime jumbo RMBS? Or is that kind of just one-month kind of dislocation and now we are kind of back to tracking along?

Richard King

No. I think there is dislocation that is going to be work through going forward. What we’ve seen is spreads on AAA have persistently widened and they really haven’t come back. And yes, and I think what’s happening there is just making I think bank portfolios have better bid for prime jumbo loans right now than conduits and so we have seen a decrease in deal flow. And I think, we need to either see rates higher, so these conduits are more competitive or (inaudible) that is straight to the borrower, or have spreads on the AAAs come back-end to really get the deal flow going again.

Unidentified Analyst

Okay. Thank you.

Operator

(Operator Instructions) The next question comes from Daniel Furtado with Jefferies. Please proceed with your question.

Daniel Furtado - Jefferies

Good morning, everybody. Thank you for the opportunity. As a follow up to the last question, spreads coming in and rates going higher on the securitization front? What, I mean, I know it’s a guess, but what would your guess be in terms of how long that market is in dysfunctional stake?

John Anzalone

Yeah. It’s tough to say but I think, I guess, if bank portfolios continue to put in our spread for prime jumbo or yields pretty close to on type of agency then it’s just not very attractive space. And I think that’s the issue how long that goes on and say it could be last. I mean, it could be -- so we just don’t feel for the rest of year potential.

Daniel Furtado - Jefferies

Understood. And so is the takeaway from the bank standpoint or would you believe happening at the banks with this more aggressive been for jumbos. You think their [SU] in essence of you can hold -- the banks can hold those at amortized cost. So we’ll have to mark in to market like they would on the same agency or sometimes RMBS or just something else driving that the behavior?

John Anzalone

I think that’s probably a big part of it and then just maybe the prime jumbo customer basis of strong bank customer.

Daniel Furtado - Jefferies

Got it. That make perfect sense and then turning to the securitizations you guys did this quarter, I notice the accounting for the financing so you bringing the -- all the loans on your balance sheet. Over the course of time, I know they are not really on your balance sheet but from an accounting perspective, over the course of time, would that help you to in essence push away from the 55% agency requirement in terms of the whole pool test for those qualified for whole pool assets?

John Anzalone

Yeah Dan, it’s something that we certainly are exploring as we think that’s a distinct probability that we’ll be able to view that overtime. We certainly see those as -- we’ll consolidate. The rules are kind of tracking on that. So I don’t want to get into a long discussion on that at this time. But we do see that as an opportunity in the future that we can move away from, how they meet 35% of your agency and be able to use this securitizations, yeah.

Daniel Furtado - Jefferies

Got it. And without getting into the technical aspect of that conversion that I assume given the right environment, you’d be willing to reduce the agency exposure below the 55%, in fact they qualify from an accounting perspective?

Richard King

Yeah. You’re actually correct, Dan, that’s the case. We prefer that credit launch allows the agency credit crunch allows the agency trade yeah.

Daniel Furtado - Jefferies

Okay, and then my last my question in this – I think it’s more of just a calculation question and thank you for the answers. Is the agency leverage – well I just do a more simple leverage calculation if I look at the delta between the Repo funding and the fair value of the agency, I get a different leverage number than you’re reporting? Am I missing some equity contribution or am I just (inaudible)?

Richard King

Yeah, you’re probably missing some of the equity contribution and Dan was it the challenge you have when you do a number like that is and you’re allocating it pocket. What we do is we take the entire balance sheet and we allocate each aspect of the balance sheet both assets and liabilities to the pockets to which they – not to try are applied. And so for example, we allocate pass to the individual strategies, we allocate the hedging strategies since most of those are for the agency side predominantly to the agency. So you’re probably dismissing some rule nuances of that and that’s a little challenging to do I understand. So it’s not during a lot of this ballpark that we’re at, I think you probably can be probably close to what we’re doing.

Daniel Furtado - Jefferies

Got it, thanks for the – thanks for the color everybody. Take care.

Operator

Mr. King there are no further questions from the phone lines at this time.

Richard King

Okay, thank you operator and thanks everybody. Once again I appreciate your time today.

Operator

Ladies and gentlemen that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.

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