Invesco Mortgage Capital (IVR) at Morgan Stanley Financials Conference (Transcript)

| About: Invesco Mortgage (IVR)

Invesco Mortgage Capital Inc. (NYSE:IVR)

Morgan Stanley Financials Conference

June 10, 2014, 03:00 PM ET


Richard J. King - President and CEO

John Anzalone - CIO


Cheryl Pate - Morgan Stanley

Cheryl Pate - Morgan Stanley

Okay. So, I think we'll go ahead and get started. Good afternoon. Next presentation, we have from Invesco Mortgage Capital, a hybrid REIT formed in 2009 with a unique strategy that invests across the sector of agency MBS, non-agency MBS and also CMBS.

With us today from Invesco are Rich King, CEO; and John Anzalone, CIO.

And with I'd like to pass it over to Rich and John. Thank you.

Richard J. King

Thank you Cheryl, and thanks to Morgan Stanley for hosting us here today and I want to welcome everybody to the presentation.

Invesco Mortgage Capital is progressing very well through the current environment and with a view towards the future. We're focused on providing our shareholders with a high level of income and an attractive dividend and maintaining book value stability.

And Cheryl mentioned it, but we're unique in a fact that we have a wide scope of assets that we source across the residential and commercial market, but it's also against -- across both securitized space and loan space.

And we've really expanded on our loan strategies in the last year and a half. And that's because we see opportunity forthcoming as the GSEs continue to reduce their footprint and banks reduced theirs in the mortgage space.

And Invesco Mortgage Capital has a deep team with strong credit resources and orientation that protected our clients through the crisis and we're still very focused on protecting shareholders' capital.

We see three important dynamics that we think investors, especially mortgage investors and REIT investors should pay attention to currently. One is there's -- rates are historically very, very low, so there's risk that comes with that.

Two, we see strong real estate fundamentals in the resi and in the commercial side. And then third, the new opportunities that are coming to private capital like IVR as a result of reform.

So, with those three trends, we've really focused in the last years and a half on three new initiatives which are commercial real estate lending, residential loan securitization, and also the risk sharing deals that we've been buying in the marketplace.

And these three initiatives really further the goals that we have in terms of maintaining core earnings and stability in book value as well as strengthening our balance sheet and our capital structure.

So, I think the pie chart here I have up is kind of a particularly telling graphic in terms of what the diversity of our portfolio and each one of these components contributes to our core earnings.

We don't diversify for the sake of the diversification, but really the mix does provide not only double-digit ROEs in each space, but also some offsetting risks that benefit our risk management effort.

This graphic shows the mix of our assets in terms of percentage of assets and that probably understates in some sense the diversity of our company and if you looked at it on a percentage of equity basis, what looks like more than half in agency space is actually about -- we have -- agencies are about 36% of our capital as invested in that space. So, the vast majority is invested in credit, both commercial and residential.

I think it's also notable is in the non-agency space, the credit risk sharing deals that I talked about briefly before are now about 10% of our non-agency investments and in the 30-year space, we've greatly reduced interest rate risk by reducing 30-year current coupons there.

Here, I want to talk about kind of the migration of the portfolio. So, the right-hand bar is the end of the first quarter and would line up with the pie chart that I showed you. But you can see here kind of the transition that we've been undergoing and the continued increase in the credit assets in the top half and the reduction in interest rate sensitive assets in the bottom half.

And we've accomplished this through reinvesting pay-downs and also through making sales of agency mortgages especially on strength, which is what we kind of said at the beginning of last year, we were going to do is use strengths in the market to reposition ourselves away from rate risk and that continues to go on.

And -- I'll get to the agencies in just a minute, but I'm also really pleased with what we've been able to do with our liabilities and I think investors should understand that the benefits of our strategy here isn’t just a better asset portfolio, but -- and risk reduction, but also an expansion in our financial flexibility.

So, in the table on the bottom, you can see that for the first three years 2009, 2010, 2011, we financed exclusively with repurchased agreements. And in 2012, we issued preferred; in 2013, we added securitization financing and we also issued exchangeable notes in events of a taper discussion and we continue to create better financing for shareholders and -- with more permanent sources of funding, better cash flow matching and even lower cost.

This year, we set-up a captive insurance company with the gained home-owned bank membership towards the end of the first quarter and we've financed commercial mortgage-backed securities there and plan to continue to diversify funding and reduced funding as well.

Well, let's take a quick look on the agency side of the business. I mentioned that we've reduced interest rate risk. Our total interest rate risk that is what we call equity duration or for a 100 basis point rise in rates, how much book value should move. And that's down to about 3%. So, 100 basis point rise in rates 3% move in book value.

So, it's really quite low interest rate risk and what we've seen recently is really no correlation. As in the fourth quarter of last year, rate was up, book value was up; first quarter rate was down, book value was up.

This quarter, we continue to see book value improve and at this point, I think we announced up like 3.5% to 4% one of the last conferences, it's now like closer to up 5%.

So, we're continuing to see good strength in the portfolio and as I said we're using demand and light mortgage supply to reduce 30 years and we believe that we're going to continue to see some opportunities to do that.

And -- but we're not trying to get rid of agencies entirely. I mean there are still parts of the agency market that we do like. And -- for instance, the up in coupon, we think that that's great value and gives us some pretty attractive yields in this low prepay environment and we think that its better value than -- for instance, the IO market or the MSR market at this point. So, we do like that and we continue to like agency hybrids and we've continued to add in that space.

In the non-agency or non-government guaranteed residential space, we've increased our holdings. And we've increased the credit risk transfer through participating in all the transactions that GSEs has done and then also in the legacy RMBS space, we continue to look to add. We found some opportunities and they continue to perform very, very well.

And then in addition to that, we closed a securitization in the first quarter, we closed to 290 million where we put, you know, the 290 million of loans under balance sheet and issued triple A assets backed securities or RMBS on the liability side.

And then we do another 270 million transaction in Q2. So we continue to make progress in the residential loan front. And those were held to maturity and will also reduce book value volatility.

In the CMBS space, we continue to add positions. And we have taken opportunities to move out of some subordinate positions that had some exposure to weaker performing retailers which is very not a meaningful amount that with where spreads are in prices we have always been able to do that, taking gains at tighter spreads.

But CMBS is also interesting and it lines up very well with home-own bank, and they captive insure relationship. And we have been able to improve ROEs in that space and continue to grow the CMBS positions. We have made some significant progress there in the second quarter.

Talk a bit about book value stability and where we have been, where we are going. In the first quarter we did see book value grow by about 3%. We are very well hedged from a rate perspective, so as really the credit assets outperforming the currency appreciation and that's been true as well in the second quarter.

On the right, you can see that core earnings have been quite stable in the $0.46, $0.47 range. But we also have seen better improvement in comprehensive income because of the improvement in book value.

On slide 13 here, we show that over the past three quarters we have maintained the stable dividend, that's the light colored bar on the left. We have shown increasing book value performance which is the middle bar, and that all translates into better economic returns for shareholders on book value which is the green color. And that should hold true again in the second quarter. So we have had a year of very good economic return performance here.

And we believe that our stocks performance should improve over time as we demonstrate stability of dividend and stability of book value in different environment. And we suspect that after reception can help us close the gap between the way the stock is and the underlying value of the portfolio.

Which brings us back to really the two important goals that we started with in our value proposition and that is produce attractive dividend and minimize book value volatility. And I think it’s pretty easy to see over time that the accumulation in dividend is just far outweigh book value volatility.

And you can see that we compare $14 through the first quarter in dividends in the last four and a half years with -- essentially we are about 50 -- within $0.50 of IPO price in terms of book value.

So when you consider the appreciation here in terms of dividend, it’s a very attractive proposition over a period of time. And so with that we have had I think cumulative economic return since inspection about 14.2% through the first quarter annualized.

So why all of the focus on maintaining book value volatility given that, you know, the dividend is really the driving force here. And the reason is we really want to maintain earning power.

So we need to keep book value volatility stable to continue producing attractive dividend and building and maintaining liquidity and being strong holders, be buying on weakness when markets are volatile.

The second is that, we're really focused on taking the type of risks that cause temporary swings in book value and not taking the type of risks that cause permanent loss in terms of book value. So we've had no credit issues. As I said at the beginning, the team is super focused on detailed loan level diligence and so we protect shareholder capital from that standpoint.

And then we also believe that with -- as I said, interest rate, even though they may stay low for a while, and we believe they probably will, we don’t want to get our dividend from -- really taking lot of interest rate risk, because that can cause the type of permanent book value loss that we don’t want to see.

So we really -- have really focused on getting our earnings from -- earning relative value and attractive credit spreads and we believe that credit spreads are likely to continue to tighten here and continue to grow book value. So we are confident in our strategy here.

So we are company that is different in this space, different because of the breadth across resi and commercial and a viable both securities and loans strategy. We've also improved the structure of the company in the funding cost and we have the resources to do that well. Our goal is to produce attractive returns now, next quarter, next year and not be subject to rate swings in terms of what we do, in terms of book value and earnings.

So we want to be -- we want IVR to be a company that income oriented investors want to hold in any environment, and we are excited about executing on that plan and seeing the results accrue to our shareholders.

That’s all I have to say today. But we will open it up for question and answers.

Question-and-Answer Session

Cheryl Pate - Morgan Stanley

Sure. And let me go ahead and kick it off. Rich you highlighted very interesting initiatives that you are spending some time on, the commercial real estate loans, the residential securitizations and then the GSE Credit Risk sharing.

Can you give us a sense of the relative availability and attractiveness of each of those initiatives as to how you think about sort of the incremental dollar of capital?

Richard J. King

Right. Yeah. I mean -- I think as I kind of mentioned in the presentation, we were looking for double-digit ROEs across all the space. So in each of those spaces we've been able to do that. The risk sharing or credit risk transfer deals are very steady and increasing in amount. And we -- so we've been seeing a pretty good supply there and we'd expect that to pick up.

In terms of the CRE space there is a big amount -- there is a large amount of commercial mortgage maturities coming up, because there was a lot of commercial mortgage financing was done in 2006, 2007. So you come up on 2016, 2017, these are 10-year deals. So you should see a lot of volume pick up there in the next couple of years.

We're also focused in the commercial real estate space, in the mezz space and we are also looking at expanding and doing some things in Europe. So we have a large team in Invesco real estate that helps us source there. So we think that’s a really attractive space for the future and some place we can put significantly more capital work over the next couple of years.

And then the residential loan space, we've been pretty steady there as well. We've put over I think $1.2 billion of loans on our balance sheet and we've been getting done a deal a quarter.

And we think we will continue to do that. At some point when the market become more developed over the next number of years we will probably change our approach there and move towards more of an aggregation strategy.

But in the short run it's not worth it for shareholders, because they -- just the volume of transactions is not large enough to carry the cost. So we've been able to keep cost very low, but still get one deal per quarter done.

And as I said, its double-digit ROEs for us and it's also a risk reducer in the sense that its securitization financing as opposed to repo financing.

Cheryl Pate - Morgan Stanley

All right. Just one last one for me. You guys have been very much at the forefront of extending the duration of your funding and -- through the FHLB program that you set up. I think that’s been important differentiator in your strategy. Maybe you can speak to some of the dynamics of that funding strategy?

Richard J. King

Sure. Yeah, I mean, we've -- we have been -- we've been hedging with some longer dated swaps, because we have some of our assets like 10-year CMBS, you don’t want to hedge that with 2-year swap. That’s not a good interest rate hedge.

So we've, I think, done a good job of keeping not only our overall duration risk down, but also our key rate duration, if you will. Because the curve is pretty steep and it can move around. So we've been focused on hedging the right part of the curve.

It's really paid off. As I said, we haven’t seen a lot of correlation between book value and rates in the curve. So I think the hedges are working there. In terms of Home Loan Bank, there are lot of things that are attractive about that. I think, A, our mission to provide financing for the mortgage market is in line with the Home Loan Bank's goal of doing the same thing.

The -- we have a captive, it's regulated and -- so it fits from that perspective. The funding itself is attractive and then its longer term. We can do -- we can match the funding to our asset strategy.

And it's also -- it's nice from a cost perspective as well and we probably report our financing on CMBS by probably a percent -- improve the net interest margin by like a percent on what we've done there. So, that’s pretty exciting.

Cheryl Pate - Morgan Stanley

Great. Maybe we'll see if there is any questions from the audience at this point.

We've spoken a lot about the opportunities on the non-agency side of the portfolio, how do you -- what do you expect to be sort of a normalized equity allocation towards the credit strategy? Overtime can we see that move up higher from where we are today? And then within the various buckets where you are seeing the best IRRs or ROEs at this point?

Richard J. King

Right. We don’t have a predetermined asset mix. What we are really focused on is the ROE and having a portfolio that is diversified such that we were more likely to earn that ROE and keep book value stable in multiple different environments.

So we are attracted to securitization and the commercial real estate, because it really doesn’t involve financing. We are not -- we don’t have to roll over securitizations, financing in a commercial real estate space we largely don’t need financing at all, and very little in the risk sharing space.

So, we think that those strategies are likely to be there for the long-term and that we will continue to put more and more capital in those spaces. We think in the agency space at some point here we're going to get past the quantitative easing that the Fed is doing. They will be out of the way.

Mortgages prices, agency mortgages will settle into evaluation that is not manipulated -- or manipulated may not be the right word, but it's not affected by what the Fed is doing.

And at that point, we will be able to make a better estimate of how much we want there. And as I said there are lots of parts of the Agency market like, you know, hybrid and up in coupon that are still attractive value.

In terms of the percentage of the portfolio, we will probably continue to reduce the Agency. But I wouldn’t expect it to go away. And I think that's really all I can give you at this point.

Cheryl Pate - Morgan Stanley

Sure. Take a moment again; see if there is any questions in the audience. One thing that was clear on the chart that you put up on dividend versus book value and core earnings is the last couple of quarters, we have definitely seen a nice rebound on the earnings side and the dividend has been trailing that to some degree.

Can you talk about how you think about the dividend over the next couple of quarters, and what sort of dynamic you expect will drive sort of the earning stream relative to that?

Richard J. King

Sure. We are seeing steady earnings. I think that looks -- right now, we don’t necessary giving earnings or dividend forecast. But I am pretty confident that we can share stability in earnings and dividends and, you know, for the next few quarters.

Cheryl Pate - Morgan Stanley

And then maybe just on the Agency side of the portfolio, one area that's gotten a lot of focus over the last quarter in particular is the dollar roll strategy and the benefit to the net spread. Do you employing that type of strategy? How do you think about that in relation to your overall view on your Agency portfolio?

Richard J. King

I mean, our asset strategy really drives -- I mean is the most important thing. And we don’t really want to be in current coupon 30-year that the Fed is buying because there is just the risk that when they stop and, you know, supply ultimately become bigger than Fed demand, that spreads widened.

So to us it’s like why, you know, you don’t want buy current coupon 30-year just because of the dollar roll financing attractive. So we are really not participating in that.

Cheryl Pate - Morgan Stanley

Okay. Great. Good. Well, I would like to thank both Rich and John again for presenting today. Thank you.

Richard J. King

Thanks everyone.

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