Invesco Mortgage Capital Inc (NYSE:IVR)
JMP Securities Financial Services and Real Estate Conference
October 01, 2013 11:00 am ET
Rich King - President and Chief Executive Officer
Trevor Cranston - JMP Securities
Trevor Cranston - JMP Securities
Okay. We are going to get started with our next presentation here. I am Trevor Cranston. I cover the mortgage REITs, along with Steve DeLaney for JMP.
Next presenting company today is, Invesco Mortgage Capital. Ticker, IVR. Invesco is a hybrid REIT that's externally managed by an affiliate Invesco Limited. The company is one of the more diverse hybrid REITs in our coverage universe. They invest in a variety of assets including, commercial mortgage-backed securities, agency mortgage-backed securities and non-agency MBS. They have also recently been making investments in newly originated jumbo whole loans. The company recently declared a $0.50 dividend through the third quarter, which gives the stock 13% yield on the current share price and the company, is a market cap, just north of $2 billion.
Presenting for the company today, we have the CEO, Rich King, CIO, John Anzalone and CFO, Don Ramon.
With that I will turn it over to Rich.
Thanks, Trevor, and thanks for hosting us the conference and appreciate all of you and your interest in Invesco Mortgage Capital.
I'll start out here talking a bit about the current environment and we feel good about where we are. Things here in the near-term, [really] by how we came through what was really a kind of a realized stress test, if you will, in terms of what we saw. Rates were up about 140 basis points from early May through early September. Obviously that's come down about 40 basis points or so since then.
Spreads on credit assets over that period were significantly wider. CMBS, 2.0, 3.0 sub-type bonds, AA puts a probably we are up an additional 50-basis point and single As more than that. Agency and agency mortgages underperformed hedges over the period, especially in light the June-July period, they have done better since then, so it was really the case where rates went up a lot, but we feel good about the rate hedging we had on, but we had additional increase in yields from spreads.
We didn't get the bassets that we would have thought from the diversification, but I will say I mean from a risk management perspective, we feel everything worked kind of as it was supposed to and that our rate hedging was quite good. We never were forced to sell assets, we bought some pretty attractive value in agency hybrids when they underperformed as well as some CMBS and legacy RMBS credit. Over the period, we even actually before the tapering announcement, or the no-tapering announcement, we were able to rebuild our cushion.
We always go at every point we are looking at what's our one standard of [duration] that went over year at the two, at the three, make how much equity drive down could we have. How much liquidity down could we potentially have and we are keeping multiples of that, so it's pretty good exercise that we went through what we did and we have the same kind of level of cash on encumbered assets that we had going into it.
Given that we have managed liquidity and risk pretty well, we have been able to continue to move in a fashion to reduce our rate risk and repo leverage as we set out to do at the beginning of the year. I think, importantly this quarter book value is about unchanged, so we early recorded there is rates continue go up a fair amount and even then this quarter we didn't see spread widening like we did in the second quarter, so we never had a big amount of book value often in this quarter.
I think a lot of this tapering, obviously, was out front in center of the media and so forth and that as we sought really just kind of put a little more force behind the headwind which was rotation out of bonds into stocks and driving interest rates, real rates up somewhat increasing (Inaudible) selling widening credit spreads as well, so we saw a pretty significant re-pricing of assets and obviously a re-pricing of stocks in the mortgage REIT space, but a lot of that based on factors that I think are misunderstood or misinformation, premature look at what the Fed is going to do.
Fundamentals speak - quite a different picture. Here's just kind of what we believe about the current environment and therefore obviously how we are positioned that the economy is doing somewhat better. It's not like it's doing great, but it's doing somewhat better, still held down by political concerns, by deleveraging [tire] regulation, fiscal policies, global uncertainty, et cetera, but the good news is inflation.
While it's likely to remain low for several years, housing prices are probably going to continue to improve. We don't see a case where we have like home prices dropping even as the economy softens some. We are just not in the overdone condition that we were that led to house prices dropping before.
Employment is improving, but not nearly as much as implied by the unemployment rate, obviously, because of just participation rates and so forth, but market policy has had an impact and we think it probably has a moderating effect on the economy given that despite not tapering, we still have interest are 50 basis points to 100 basis points higher than where they were in May depending on part of the curve you are looking at.
We don't expect any tapering this year and certainly not in mortgages and I think that means that 30-year mortgage spreads are likely to outperform and even though they already have, because the amount of buying that's going on from the Fed is, I think in the period like in June-July, when the spreads were one-year it was only over half of the gross supply and that could get up close to 100% if refis have gone down, the gross production is down quite a bit and the Fed continues buying, so given that 30-year spreads. 30 years aren't quite as attractive as they were, but it's still a great reinvestment opportunity for us.
Our ability to sell agency mortgages as they richen and deploy that capital into credit assets and CRE debt is great for our company, one of the benefits of being as diverse as we are, and we do see fundamentals continuing to improve in housing and in commercial real estate, so we remain focused on the portfolio and adjusting to this economic climate.
Book value was in front and center in our minds as we continue to earn attractive dividend that we believe is sustainable. In the short run, we see rates may decline a little bit around the fear (Inaudible) with shutdown or worse than debt default, but we think we have seen the lows in interest rates for this cycle and secularly we will probably see rates go upward some, not rapidly and we are (Inaudible) the portfolio to earn attractive return in the economy that recovers gradually.
Given that, in 2013, we reduced our interest rate risk, our equity duration, if you will, by about 40%, and we reduced our overall repo leverage a full turn to about 5.5 times. We have added more hedges, so we are inflated from [IV] rates. We have moved some  into agency hybrids. We saw in agency hybrids production picked up as rates went up and a typical agency hybrid buyer seem to be a sidelined and so we saw some pretty good value there. We continued look for opportunity to add legacy RMBS and CMBS, so that's essentially - I think, one key thing is, in managing to higher rates and higher vol, we are hoping about 40% of our equity and cash and unencumbered which inflates us from adversity and gives us dry powder to deploy, so at this point our ability to put capital to work and should we see some spread widening is important.
We believe Invesco Mortgage Capital can provide a strong return to investors in the next year and beyond and let me just talk a minute. Near-term, we see improving fundamentals. We see there an opportunity to invest in credit low. We have very, very strong underwriting in resi and commercial. Commercial is not quite as strong as it was in, say, 2011, but it's still quite strong. We like to see yield curve and credit curve. We see slower prepaids, and I think there was a misperception out there about really impacts us the most. Since we are not that exposed to movement in general level of interest rates as people seem to think, has kind of created a pretty big discount in stock price, and given that there is a very steep forward curve, we are seeing room for rates to rise and still generate a strong return.
I think it's important to point out that from the middle of 2012, until today, rates were about 100 basis points, and economic return, that is based on exchange and our book value and reinvest dividends, the economic return is about 11.5%, so it seems to not see that when you see like the discount in the stock price is down somehow, but fundamentally what we have been able to do in a plus a 100 rate environment really is attractive.
The second reason we are excited about and I am excited about earning Invesco Mortgage Capital is really the long-term opportunity is really good. We are still very early on in the churn of the securitized market. We have been very patient not to expose the company to a lot of risk of putting all our infrastructure cost in what's really a very start-stop environment on the resi side in securitization, but - we have been involved. The last four years were all about taking advantage of this location, but the future is going to be about real ongoing opportunity in U.S. mortgage market, and especially as the GSEs see the [roll] and our company is set up to benefit from these opportunities.
What we are really focused on is emphasizing these strategic loan assets on both, the CRE and resi side. We want to take advantage of the void in risk capital behind securitized credit, capture attractive yields, take advantage of this kind of strong underwriting environment that I spoke about, reduced interest rate risk that return matching, reduced reliance on short-term borrowings and we are really making steady progress on all those fronts.
Let me just give you a quick update on the residential whole loan securitizations that we have done. We have done four deals in 2013, $1.5 billion of loans and we retained the subs and IOs on that book.
What we've seen is LTVs, because home prices are improving, what we are like in the high 60s already in the low 60s on that book, so our credit risk has dropped pretty meaningfully. Speeds were going about as expected and delinquencies are nonexistent, like zero delinquencies, so it's just a very, very strong book of business that we would like to grow in the future. We completed these deals at super low risk to the shareholders we were able to capture some attractive returns by locking spreads on those liabilities.
On the resi side, aside from the securitization front, we are seeing some opportunities as the GSEs liquidate credit assets, legacy assets and we also see opportunities as the risk sharing deals continue to come to market. We would like to see them structured somewhat differently, but given that it's still a pretty attractive opportunity and the new deal that's coming from Fannie, we do like better than the Freddie deal, so a 25% more credit enhancement.
Now let me discuss real quick what we are doing on the CRE front. We are committed here on commercial real estate lending to creating franchise in this market. We look at it as a permanent business, not non-opportunistic one. We are looking to make loans that are primarily floating rate loans. We plan to execute the program in both, the mezz space and the whole loan space and focus obviously on strong properties. Again, we are patient. We don't have to necessarily deploy the capital today. There is a huge wall of maturities coming, primarily like 2016-2017, but we think a lot of these deals will get refinanced in front of that.
In summary, we remain very focused on overall risk management. We are very well positioned from a risk environment. We performed very well in terms of liquidity. We have the same liquidity position and as much cash and encumbered today as we did before rates went up 140 basis points. We have been able to reduce leverage. We have been able to bring down repo borrowings. By the way, we do get a lot of questions on repo and we haven't seen any change whatsoever in that market. I mean, we have seen on-year rates have actually come down on repo which has been helpful, nobody has lowered our balances. The only thing that we have seen more banks that want to lend more rather than less, so there is nothing on that front in the near-term, but in the long-term, we are moving more capital into spaces that they are just aren't reliant on short-term borrowings.
We are very focused on managing risks very - focused on continuing to deliver attractive dividend and the opportunities near-term are attractive, the opportunities in the long-term I think are tremendous, so we are just very excited about the future for IVR, and I would like to thank everybody.
That's the end of the remarks and open up the Q&A.
Trevor Cranston - JMP Securities
Questions from the audience?
Do you have a target or potential size of the CRE that was either as a percentage of assets and equity and I guess, I think in June you had like one month $9 million.
…how big that is in terms that if you diversify…
We are looking at something like 25% of our equity.
Of your equity?
Okay. Would that include CVS and…
Yes. I am not saying that's going to happen in the near-term. That is going to take a couple of years probably.
On the resi whole loan side, you guys have been a little bit active there. I think the slide show. We have seen some articles in last few weeks that mentioned some of the large banks offering rates on jumbo loans that are well below or the kind of securitized market is pricing rates, so maybe just talk a little bit about what you are seeing in jumbo space and how you think that opportunity play over the next couple of quarters?
I think essentially what happened there is, when rates went up, the amount of just gross production in the jumbo space dropped, because a lot of it was refinancing and at the same time, when the AAA market so, I think, early in the year, I think Redwood was about to sell some triple AAA inside 100 basis points, so LIBOR - I think our first deal was something like 125 basis points in the last one month maybe 180-ish, but on every one of those deals, I think like I said, we locked spread when we did the deal, so that we weren't taking a lot of ROE risk there, but those spreads have continued to widen now another mark 270, so the market for buying AAAs off prime jumbo securitizations or any resi securitizations just haven't developed yet, so therefore I don't think it's an economic business right now, so the good thing for us is we have a lot of outlets for capital and we haven't built the infrastructure to do that.
I do think, or we do think that in the long run that that market is going to return, but it hasn't yet. I think, we have to see a period where spreads probably are too wide and maybe they get wider in that space, but at some point they are going to start coming in and I think it will build on itself.
Right now, there isn't the volume of loans available anyway, so like if you are trying to warehouse residential loans whereas you can buy 50 million of loans a day in February or something. That's probably than literally decimated, so the warehousing would be very difficult, so we are in a good position, we've put money to work, like what we've done, but can be very patient about going back into that market.
Trevor Cranston - JMP Securities
Any other questions?
Maybe just one quick follow-up on that one. As that market kind of develops and becomes more fully formed, is the strategy for IVR to build out more better infrastructure, so you are kind of originating your own loans for kind of your own securitization itself, or do you guys envision yourself as more being a lone buyer and doing it in capital markets.
We would be more of a lone buyer. I mean, we don't have any intent us creating an origination platform. I think, the idea is we are credit investor. We are not an originator and we have a great ability to identify credit risk and to be like first class credit, but we have outlets to do that in CRE space, we have outlet to do it in a risk sharing space. You can do it in the legacy RMBS space. We do see opportunities as well in agency space and hedge returns look pretty attractive from here.
Just cloud coverage, Fannie structure (Inaudible) that was in the [Freddie]. Will you participate in those?
Combination of reasons, at that time we were able to do the resi deals and we were looking this versus this, the resi deals gave us a better all-in ROE, and we like the fact that we could do our intelligence on each loan and so forth, but the scraper deals, I think they are attractive and I think we want that market to develop, because I think in the long run, it's going to be a very big market.
Trevor Cranston - JMP Securities
Great. It looks like we are out of time. There will be a short breakout across the hall in the Rambler Room, so thank you guys.