Invesco Mortgage Capital Inc. (NYSE:IVR)
Credit Suisse Financial Services Forum
February 11, 2014 03:15 PM ET
Rich King - CEO
Tapfuma Chibaya - Credit Suisse
Tapfuma Chibaya - Credit Suisse
Good afternoon. My name is Tapfuma Chibaya, one of the Credit Suisse research analyst working alongside Douglas Harter. Today I have the pleasure of introducing Invesco Mortgage Capital, a hybrid mortgage REIT. Joining me today from management is Rich King, the CEO and Don Ramon, CFO and John Anzalone, CIO. With that I will hand it over to Rich.
Thank you. Well, thank you all for coming and we are going to put our earnings out obviously next week. So, rather than focusing on financials and numbers that you have seen since the end of the third quarter, we are going to talk more about the trends we see in the market, the initiatives that we have to capitalize on the trends that we see and then our platform and why we are well set-up to take care of those. And really we are keen on three investments that we really like. The first is quickly let’s talk about trends in the mortgage market and I think clearly over the last year, investors have been very concerned about interest rate volatility, about tapering and how long this effect is going to remain, accommodated 0 to 25 in rates.
And while recently it looks like we could be in for stand in the rate range for longer than maybe some people thought last year. We still think in the long-term rates are going up and so we are orienting our strategy to take advantage of the trends we see here.
Second is improving credit fundamentals and what we see is valuations are improving, that’s both on the residential and commercial side. The consumer is getting stronger, underwriting on both residential and commercial loans is strong, we see shadow inventory falling and so we are also orienting our investments to take advantage of those trends.
And then lastly we are looking at the opportunities we see where private capital can step into the market in ways they really haven't in the past. And that also is on the residential and commercial side and in places where government and banks used to dominate the markets but now there is a place for private capital.
So, the three things that we think fit best with these trends are residential loan securitization, GSE risk sharing and originating commercial real estate loans. Invesco Mortgage is well positioned to take advantage of these trends. I think we have the right business model in terms of we are opportunistic.
We think that things that work best two years ago or three years ago are not the things that work best today and going into the future. And it’s important to have an evolving business that can take advantage of these things. We have a really strong team, I am very proud of the people that we have and this is the same team that avoided a lot of the problems in the crisis. So, we are good at underwriting credit and very disciplined in that approach and we have all the right resources with global platform that has the best analytics and data that you can buy, we built proprietary models based on some great data. And the global relationships that we have through being part of Invesco are really important and especially in a world where, maybe not today because we have seen nothing but improving levels of repo financing out there in the marketplace and even repo rates are improving recently. But it’s clearly something that you need to be aware of and in front of, and having relationships with lenders who do business with us in all different sorts of ways makes us an important partner to them not just the other way around.
And then finally our real estate business is really central to what we are trying to do going forward and unlike maybe some other people who are trying to get involved in that one market we don’t really have to rely on third-parties to sourced assets. We have a team internally that can do that.
Let me turn to the next slide and talk about basically why we exist, why we -- what we believe in and the first thing is create and maintain shareholder value. Second is that we want to be opportunistic and diversified and then the last is that we do believe there is a place for us in filling our void in the market.
And what do we mean by creating shareholder value, really we mean we want to generate strong core earnings. We want to pay an attractive dividend from those core earnings and by maintaining we mean in terms of book value in order to continue to generate earnings off of that principal. And the big points underlying that, that we know we have to do is one is prudent asset selection. If you build a portfolio based on high quality properties with high quality borrowers you are going to be a lot more stable than if you build like something off of riskier borrowers that maybe you get more yield but you are going to have a lot more volatility over the long run. So, we really focused on quality. We are focused on -- focused in [indiscernible] that we’re we have enough resources to work across all the real estate markets and essentially just fish in a bigger pond to find the best opportunities not only on the asset side but on the asset liability side. And I think really focusing on assets that don’t need as much leverage on less volatile assets with less volatile cash flows and assets that lead us to better liability structures. So, in terms of building out an portfolio that’s diversified and risk managed we view risk dynamically, we don’t look at kind of a static view and we’re looking across rates, credit, daily cash flow, liquidity and volatility. And creating a good asset liability management is really about starting with the assets.
And then lastly and filling in a need for private capital, so as I go through the next number of slides, I want to keep in mind that on page four that we love the credit environment that we’re in right now. I talked about improving consumer and so forth and strong underwriting. But we want assets that can meet our return targets with lower leverage. We want assets that either have short duration of floating rate and we also want assets that lead us to better financing. So in the category of assets that have less leverage and still meet our return targets, we really have identified the commercial real estate loans are very attractive. We can get very nice unlevered yields in that space in terms of the resi space buying loan packages and selling off AAAs and retaining subordinate interest gives us locked up financing and meets our return target without really having to worry about funding. And then also the same is true with the risk sharing. And in all these places we’re shooting for about 12% return on equity. We don’t see these strategies been impacted by the fed stopping their quantitative easing program by bank leverage ratios, by rates rising, they should all be pretty resilient to that.
And so the last thing is some of these assets, if you got agency mortgages and you have a NIM of 130 basis points you really need to borrow a kind of shorter term to make that work. And then hedge, but then you have the obviously the complexity issues and that goes both ways whether rates rally a lot or back up a lot and with the three strategies that I am talking about today we really avoid all of that. And we think that these strategies can we can deploy about 75% of our capital over the next few years in these strategies and be opportunistic and continue to do the things that we do now. So we’re not going to completely get out of the agency market we’re not going to get out of the legacy market as long as there are legacy securities to buy. But these are all things that are going to be around for a long-long time. And so let’s get into those.
On page five, the first one I want to talk about is commercial real estate loan origination. And we really think that if you actually try to put these in order this would be our favorite. Because it’s really attractive because it’s a really good match with not only our return target but -- and with floating rates et cetera but also just competitive advantage. We are Invesco real estate who’s a terrific partner to us. As I said sourcing ability to if we’re going to have a very diversified portfolio within the event that we need to step in to a particular asset and manage it, take over for the equity. We have a group of people that’s what they do. And so it’s not a stretch for us to be able to handle difficult markets in the space and we can do that at no additional expense to our shareholders.
So we think we can really grow the premium that our stock trades by being in this space. And we’re also seeing improved liquidity in the mezz loan pace, we’re starting to see a secondary trading pick up in the space and also in key mezz market as well where there are some opportunities that we have been able to pick up.
In terms of the size of that opportunity and you can see on the chart up there on the right that we’re seeing about 250, little over 250 billion of loan maturities in commercial real estate this year and that’s ramping up over the next three years to something over 400 billion. So in a market that’s about 3 trillion, we think that there is going to be about 1.3 trillion of that maturing over the next four years counting this year. And we expect that there will be about 100 billion of opportunity in the mezzanine space. And so we have intended to deploy about a quarter to a third of our capital in that space over the next three years, we think we can hit target ROEs of 12% and use modest leverage on top of the unlevered yields to hit that.
On page -- next slide six; the opportunities in the residential securitization market, on the upper right you see the kind of cliff that is the RMBS market. And from 2000 to 2007 there was a huge amount of issuance in a lot of -- especially in like ’05 through ’07, that underwriting which I mentioned earlier we avoided. But we approached this by being a partner, we think that we can grow in this space, but the timing is difficult. So it can be a very long ramp, we think that there will be a growing market every year you will see more residential securitization than the last, but to put on a ton of infrastructure today in terms of aggregating loans, is not the way to go it’s better to be a partner and we can grow in that market without creating a lot of expense for shareholders, and still hit a target ROE of 12%.
In this space we have seen some recent change with FHFA leadership and whereas prior you saw GCs being increased and conforming loan balances taken down at least one step. There may be a certain amount of time before we really see much change in that space, but we do think and we have a strong credit underwriting team and we believe that AAA residential market is going to continue to improve in valuations. So we like partnering and taking down a securitization, taking the execution risk on the AAAs, and retaining the subordinate interest.
The last opportunity I want to talk about today is risk sharing, and again it’s another place where private capital has an opportunity in the marketplace that hasn’t been there before, the first deals were just done in 2013. FHFA had asked each of the agencies Fannie and Freddie to basically risk share 30 billion each last year, and each agency did complete transactions in 2013 but they plan to grow the volume this year. And we think this has actually become very central government policy, they like the way this program is particularly working and we think that they’ll try some new structures and potentially even issue senior subordinate structures and potentially even place AAAs rather than issue agency MBS. But in any event of the size of this opportunity you can see on the upper right on the chart that the pool issuance, the annual mortgage pool issuance has been somewhere between 800 billion and like 1.2 billion roughly or trillion excuse me, over the last five years.
And last year for instance the risk sharing deals referenced about 88 billion of original principle balance. And so that was about 7% of the pool issuance. Next year or this year we expect there to be both agencies to do deals every quarter. So we should see a significant increase in the size, it could be referencing something like 250 billion out of a trillion or so maybe quarter of the issuance and so we do see some big opportunities there. There is great demand for this. We’ve seen some pretty good appreciation in our risk sharing assets that we’ve put on so far. But we still think we can hit target to return at 12%. And we get the same kind of benefits that we get for retaining subordinated interest in residential securitization. We get those benefits here in terms of not -- you get structural leverage. This is a floating rate asset, which is even kind of better than retaining fixed rate subordinated interest. So we get a floating rate asset. So over time to the forward curves right and eventually if Fed starts raising rate the returns for the strategy just improve. And that’s also a nice diversifier for the overall portfolio.
So just end it there and just summarize open up for questions. But, we believe that Invesco Mortgage Capital can deliver a much more stable book value by really moving into these strategies. We think that we can continue to hit our core earnings in these strategies. We think they did extremely well with our platform. And it’s a great way to provide capital in the market and be a synergistic partner and kind of take a place in chain of intermediaries on the resi side. So, we’re very excited, I think this looks to be a great year. We’re starting out and we’ll go over obviously all our information, financial information next week. But we think there is some great value out there in our space and specifically love our opportunities.
And I just want to thank you for listening and I’ll open up the floor for Q&A. Don Ramon, our CFO, is here and so is John Anzalone, our CIO, to answer anything that you may have. Thanks again.
Tapfuma Chibaya - Credit Suisse
Maybe I’ll kick it off with a couple of questions. So, you guys recently executed on a private label deal. Maybe can you just talk about the execution then the economics just given where AAAs are trading today?
Sure. So going in the fourth quarter last year, well, actually all throughout last year, AAAs started the year at really a strong execution maybe too rich. And throughout the year almost every tender is a deal you saw pricing on AAAs just get worse and worse. And I think we hit levels maybe in the third quarter that to us just worked really kind of ridiculous. They were just too far behind the agencies. So at that point we were interested in taking down just entire deals and not worrying about the execution because they were attractive enough we could even keep the AAAs and finance them. But that’s not the long term mission. So, we did end up placing all the AAAs on those deals. And on the more recent one we took a similar strategy and accepted the pricing risk on the AAAs but ended up placing in both cases at better levels than we priced for. So, again we can get -- you can buy -- pool something like over 4 points back from agencies and place AAAs something like 3 points back and it ends up being a pretty nice economics for us in retaining the subs.
We’ve seen this year I mean obviously the second quarter there was a fair amount of volatility but most of it was really driven by spreads on CMBS and agencies widening and not so much rate moves. But since then we’ve continued to even decrease rate risk and spread duration risk in the agency space. We’re going to put out numbers next week so I don’t want to talk specifically about where book value is. But we’ve definitely seen much improved volatility and I think this year investors should expect to see pretty stable book value out of us. I think we do expect agency spread to widen, so we’ve definitely reduced risk in that space. We actually think you’ll continue to see credit spreads though do better in the CMBS space. And on the dividend, you know we’re continuing to target core earnings that are consistent with paying out the $0.50 dividend that we had in the last two quarters.
How do you guys think about deployment of an incremental dollar today in the different markets of the asset classes that you guys are focusing on? This is, a buyback just giving that some of the [indiscernible] the stock that's trading at.
Unidentified company representative
Yes, I can talk about that so, with incremental dollars and it’s generally been allowing the agency side to kind of pay down and then redeploying that capital into either and it’s been in, you’ll see in the fourth quarter moves into both, buying back stock and as well as into the other three initiatives that we’re just talking about. So it’s not really in either or typically, because those initiatives are in, I mean they’re a little bit lumpier in terms of when we can get them done, so it’s not like you know every month we can be sure we’re going to be able to invest in -- invest money in CRE, it’s a little lumpier. So I’d say we’ve been doing all four of those things actually. We’ve been pretty consistent with buybacks and then when these opportunities come up, I mean if they come up all at once then we can obviously sell some agencies or do things like that which we’ve been -- which I could do a little bit of depending on the timing of cash flows and things like that. But, I would say all of them I mean, in fact our move or evolution towards these other asset classes I think is largely dependent on just the supply of being able to get things done, so you know we’re in the midst of the -- in the CRE space, we’ve basically last year starting from scratch and building out the platform and now it’s starting to -- the pipeline’s starting to fill up, so as we see that continue to grow on our sort of name in the marketplace becomes better known I think we’ll see that generate greater investment opportunities.
Well if there aren’t any further questions I’d just say thanks for being here and we’ll be available afterwards if there’re any further questions, thanks.
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