IVR - NYSE

Welcome to the Invesco Mortgage Capital First Quarter 2025 Earnings Call. All participants will be in a listen-only mode until the question-and-answer session. [Operator Instructions] As a reminder, this call is being recorded. Now, I would like to turn the call over to Greg Seals in Investor Relations. Mr. Seals, you may begin the call.

Thanks, operator, and to all of you joining us on Invesco Mortgage Capital's quarterly earnings call. In addition, to today's press release, we have provided a presentation that covers the topics we plan to address today. The press release and presentation are available on our website, invescomortgagecapital.com. This information can be found by going to the investor relations section of the website. Our presentation today will include forward-looking statements and certain non-GAAP financial measures. Please review the disclosures on Slide 2 of the presentation regarding these statements and measures as well as the appendix for the appropriate reconciliations to GAAP. Finally, Invesco Mortgage Capital is not responsible for and does not edit or guarantee the accuracy of our earnings teleconference transcripts provided by third-parties. The only authorized webcasts are located on our website. Again, welcome. Thank you for joining us today. I'll now turn the call over to IVR CEO, John Anzalone. John?

Good morning, and welcome to Invesco Mortgage Capital's first quarter earnings call. I'll provide some brief comments before turning the call over to our Chief Investment Officer, Brian Norris to discuss our portfolio in more detail. Also joining us on the call this morning for Q&A are President, Kevin Collins; our COO, David Lyle; and our CFO, Mark Gregson. The first quarter of 2025 was characterized by tightening financial conditions as both equity markets and credit spreads reacted negatively to anticipated U.S. fiscal and trade policies. Although inflation measures stabilized during the quarter, investors increased expectations for future inflation given concerns about the potential impact of U.S. trade-related policies. As inflation forecasts were increasing, softer employment data and fears the combination of potential trade wars and fiscal austerity would contribute to an economic slowdown led to a repricing of the market's expectations of future monetary policy. The Fed funds futures market as of quarter end reflected a further 75 basis point reduction at the target rate through the end of the year. Interest rates dropped across the maturity spectrum during the quarter, while short-dated interest rate volatility increased, reflecting the market shifting expectations of monetary and trade policy, while longer-dated volatility declined modestly. Despite weaker market sentiment, agency mortgages performance was largely consistent with treasuries with higher coupons modestly outperforming hedges as longer-dated interest rate volatility trended lower. Supply and demand technicals for higher coupon agency mortgages were supportive as originations remain subdued given slower housing seasonals and elevated mortgage rates, while banks, money managers and mortgage REITs net added exposure during the quarter. Prepayment speeds remained at low levels given limited purchase and refinancing activity. However, a notable decline in mortgage rates in the latter half of the quarter should result in faster prepayment speeds in the coming months as the decline coincided with the seasonal increase in housing activity. Premiums on specified pool collateral were largely unchanged during the quarter as the move lower in mortgage rates led to support for prepayment protection. Additionally, agency CMBS risk premiums increased during the quarter, reflecting weakness in broader fixed income markets. In this environment, our portfolio produced a positive economic return for the quarter of 2.6%, consisting of our $0.34 dividend and a modest $0.11 decline in book value to $8.81. Following additional trade policy announcements on April 2nd, financial conditions tightened further and investor inflation expectations declined as concerns about an economic slowdown outweighed concerns about potentially higher prices. Agency mortgages significantly underperformed treasuries as the initial reaction to the announcement saw interest rate volatility spike sharply higher and risk assets sell off across both fixed income and equities as markets priced in potentially slower economic growth. Further, hedge funds were selling U.S. treasuries and receiving swaps due to an unwind of a previous trade where they purchased treasuries and hedge them with swaps. This caused swap spreads to move sharply tighter, negatively impacting book value. Given this challenging environment, our book value per common share declined in April, and our estimate for April 30th is between $7.74 and $8.06. Given elevated interest rate volatility and continued policy uncertainty, we remain cautious on agency mortgages in the near-term. However, our long-term outlook is favorable as we expect investor demand to improve in higher coupons given attractive valuations and eventual decline in interest rate volatility and a steeper yield curve. Lastly, while Agency CMBS risk premiums may remain elevated, limited issuance, strong fundamental performance and stable cash flow profile should provide favorable support for the sector. Now, I'll turn the call over to Brian to provide more details.

Thanks, John, and good morning to everyone listening to the call. I'll begin on Slide 4, which provides an overview of the interest rate and agency mortgage markets over the past year. As shown on the chart in the upper left, during the first quarter, U.S. treasury yields declined 20 to 40 basis points across the yield curve with yields on shorter maturities falling more than longer maturities. The decline was driven largely by concerns over the economic growth prospects in the U.S. as fiscal and trade policy was rapidly adjusting under the new administration. The yield curve continued to steepen in April as U.S. economic growth expectations diminished further amidst growing trade policy uncertainty following Liberation Day on April 2nd. As depicted on the chart on the bottom left, the Fed funds futures market is now pricing in deeper cuts over the next two years with the target rate expected to be reduced 3 times to 4 times in 2025 and bottoming near 3% in 2026. As a result, futures markets are now pricing in a greater number of interest rate cuts than previously expected. At the start of the year, only one or two cuts were anticipated in 2025 with the target rate declining to just 3.75% in 2026. The chart in the upper right reflects changes in short-term funding rates over the past year. Positively, the funding market for our assets has been stable since year-end, with haircuts unchanged and one-month repo spreads remaining between SOFR plus 15 to 18 basis points. Lastly, the bottom right chart details Agency MBS holdings by the Federal Reserve and U.S. banks. As announced by the FOMC at their March meeting, runoff of the Fed's balance sheet continues but at a reduced pace starting in April, with runoff of the treasury portfolio declining from $25 billion to $5 billion per month and the agency mortgage runoff cap remaining unchanged at $35 billion per month. Agency mortgage runoff has been averaging approximately $15 billion per month in recent months. So, the reduction in treasury runoff essentially reduces the overall monthly decline of the balance sheet from $40 billion to $20 billion. Given the reduced pace, quantitative tightening is now expected to conclude in 2026 instead of 2025. U.S. banks added marginally to their portfolios in the first quarter, but we expect demand for Agency RMBS to increase notably in the second half of the year as deregulation, a slowing economy and a steeper yield curve provides an attractive environment for deployment of deposits. Slide 5 provides more detail on the agency mortgage market. In the upper left chart, we show 30-year current coupon performance versus U.S. treasuries over the past year, highlighting the first quarter in gray. Although lower coupons underperformed, higher coupons modestly outperformed during the quarter given a favorable supply and demand environment as well as a trend lower in long-term interest rate volatility. The sector underperformed significantly in the first half of April, however, as interest rate volatility spiked higher after Liberation Day. This increase in interest rate volatility reduced investor demand for agency mortgages and the sharp underperformance in risk assets led to a substantial amount of selling in the sector as money managers sold agency mortgage pools for short settle to fund redemptions and rotate into other sectors. The impact of these sales can be seen in the chart on the upper right, which shows specified pool pay-ups over the past year. Specified pool pay-ups declined notably in early April as the need for cash settle led to substantial selling in pools. Lastly, as shown in the lower right chart, funding via the dollar roll market for TBA securities has been attractive in the conventional 6.5% coupon, but largely unattractive elsewhere. Our rotation into 6.5% coupons during the first quarter capitalized on the attractiveness of the roll before rotating into specified pools in March. While we continue to prefer specified pools over TBA given their more predictable prepayment behavior, we will continue to take advantage of attractive alternatives in the dollar roll market as they become available. Slide 6 details our agency mortgage investments and summarizes investment portfolio changes during the quarter. Our agency RMBS portfolio increased 9.5% quarter-over-quarter as we invested proceeds from ATM issuance into 30-year 5% through 6.5% coupons. In addition, we rotated our remaining allocation from the 4% coupon into higher coupons as the relative value between coupons in the middle of the coupon stack and higher coupons became stretched. Overall, we remain focused in higher coupon agency RMBS, which should see greater benefit from a decline in interest rate volatility and demand from banks, overseas investors and mortgage REITs. We continue to focus our specified pool allocation on prepayment characteristics that are expected to perform well in both premium and discount environments with our largest concentration in lower loan balance collateral given more predictable prepayments. We increased our allocation to specified pools consisting of loans with low credit score borrowers during the quarter as the potential slowdown in economic activity should lead to slower prepayments from credit constrained borrowers. Although we anticipate interest rate volatility to remain elevated and are cautious on the sector overall in the near-term, we believe levered gross ROEs in the low 20% represent a very attractive entry point for investors with longer investment horizons. Slide 7 provides detail on our agency CMBS portfolio. We purchased just $52 million at the beginning of the first quarter as our exposure to the sector remained at approximately 15% of our total investment portfolio. We believe agency CMBS offers many benefits, mainly through its prepayment protection and fixed maturities, which reduce our sensitivity to interest rate volatility. Levered gross ROEs on our new purchases were in the low double digits, and we have been disciplined on adding exposure only when the relative value between agency CMBS and agency RMBS accurately reflects their different risks. Financing capacity has been robust as we have been able to finance our purchases with multiple counterparties at attractive levels. We will continue to monitor the sector for opportunities to increase our allocation as they become available, recognizing the overall benefits to the portfolio as the sector diversifies risks associated with an agency RMBS portfolio. Slide 8 details our funding and hedging book at quarter end. Repurchase agreements collateralized by our agency RMBS and agency CMBS investments increased from $4.9 billion to $5.4 billion, consistent with the increase in our total assets, while the total notional of our hedges declined from $4.7 billion to $4.5 billion. The increase in our repo balance and decrease in hedge notional resulted in a lower hedge ratio for the quarter from 95% to 85%, reflecting our expectation of a slowing economy and more substantial cuts in the Fed funds target rate in 2025. The table on the right provides further detail on our hedges at year-end. The composition of our hedge portfolio shifted modestly towards interest rate swaps during the quarter. On a notional basis, our allocation to swaps increased from 70% at year-end to 80% at the end of March, while on a dollar duration basis, the allocation shifted from roughly 50% to 70%. Slide 9 provides an update on the portfolio as of April 30. As previously discussed, the liberation day tariff announcements resulted in substantial market volatility in early April as risk assets underperformed sharply and interest rate volatility spiked higher. Agency mortgages notably underperformed treasuries during this time as money managers liquidated positions to fund redemptions and asset rotations. In addition, swap spreads tightened significantly as hedge funds were forced to unwind carry trades amidst increased volatility, further negatively impacting our book value. We sought to reduce risk and maintain ample liquidity by selling assets to bring our leverage ratio back down to the mid-6s from 7.1 times debt to equity at the end of March. Sales were focused on higher coupons for a few reasons, most notably given their elevated exposure to interest rate volatility and also increased prepayment risk given our expectation for an eventual softening in economic growth and lower interest rates. Slide 10 provides more detail on our capital structure and highlights the improvement made in recent quarters to reduce our cost of capital. Further improvement in the capital structure remains a focus of ours as we seek to maximize shareholder returns. To conclude our prepared remarks, financial market volatility began to increase in the latter half of the first quarter as investors began to incorporate greater monetary and fiscal policy uncertainty in valuations. But our focus on higher coupon agency RMBS and increased allocation to agency CMBS mitigated much of this impact and resulted in a positive economic return of 2.6%. Although increased volatility, swap spread tightening and agency mortgage underperformance negatively impacted our book value in April, positively financial markets have stabilized as the proposed tariffs have been postponed and negotiations began with book value up approximately 1% so far in May. We believe IVR is well-positioned to navigate current mortgage market volatility given our recent reduction in leverage. We believe our liquidity position provides substantial cushion for further potential market stress while also providing capital to deploy into our target assets as the investment environment improves. While near-term uncertainty warrants a cautious -- a somewhat cautious approach, we believe further easing of monetary policy will lead to a steeper yield curve and an eventual decline in interest rate volatility, both of which provide a supportive backdrop for agency mortgages over the long term as they improve demand from commercial banks, overseas investors, money managers, and REITs. Thank you for your continued support for Invesco Mortgage Capital, and now we will open the line for Q&A.

Thank you, gentlemen. [Operator Instructions] And our first question is from Doug Harter with UBS. Your line is now open.

Thanks. I appreciate the update on April. Can you just talk through the decision to take down leverage and kind of how you think about managing volatile periods as to whether you let kind of leverage float or you take portfolio actions like you did?

Yes. Hey Doug, thanks. It's Brian. Yes, so in April, we essentially took leverage down about 0.5 turn from where it began a month. And that just really reflects increased uncertainty regarding monetary fiscal and trade policy and how those that uncertainty kind of impacts the demand I think bank buying was fairly light in the first quarter. And I think the increased uncertainty will likely mean that, that gets delayed -- that bank demand gets delayed into the second half of the year in the midst of higher supply coming due to housing season. And certainly, the increased trade policy uncertainty could lead to overseas demand being relatively quiet as well in the near-term. So, we just thought that mix with monetary policy uncertainty just led us to want to reduce leverage modestly closer to the lower end of our range. I think as mortgages were underperforming in early April, leverage was certainly ticking higher given a decline in book value. And at a certain point, we do let it drift. But at a certain point, it gets kind of to the high end of the range. And that's when we decided to take action to reduce. And it's not something that we're doing all at once. But over the course of the month, we decided that we wanted to have leverage a little bit lower than where we started the quarter.

Great. I appreciate it. Can you just talk about where you see returns on an incremental basis today?

Yes. Spreads are very attractive, particularly versus swaps given the tightening in swap spreads still quarter-to-date. So levered ROEs are kind of in the low 20s on higher coupons.

Great. Appreciate it. Thank you.

Thank you. Our next question is from Trevor Cranston with Citizens JMP. Your line is open.

Thanks. And thank you for the portfolio update on April 30th. One question related to that. Can you comment on any changes to the hedge portfolio that were made in April along with the portfolio reduction?

Yes, hey Trevor, it's Brian again. Yes, we did increase our hedge ratio just given, again, kind of uncertainty about near-term monetary policy. We decided to be a little bit closer to home as far as the hedge ratio goes. Now, as far as the mix between swaps and treasuries, I think that's still within the range that we've kind of been stating over the last couple of quarters, kind of in that 20% to 30% range of treasury futures relative to swaps. So there hasn't been a notable shift away from that.

Okay. Got it. And then with the smaller portfolio size as of the end of April, does that have any impact on how you guys think about sort of the right dividend level for the company? Or does the relatively wider spreads and somewhat positive intermediate-term outlook sort of outweigh the reduction in the size of the portfolio?

Trevor, it's John. Yes, as far as the dividend goes, I mean, we just reduced it in last quarter. So still comfortably covering it. So, that's good. And I think to Brian's point about ROEs, I mean, what we're seeing off the portfolio and what we're reinvesting are supportive also. So, yes, I don't have -- we don't have any concerns about that, at least given where we are now for sure.

Yes, okay. Appreciate the color. Thank you guys.

Thank you. Our next question now is from Jason Weaver with JonesTrading. And your line is open.

Hey, good morning guys. Thanks for taking my question. First, I wonder if can you discuss how you see the opportunity set in Agency today compared to the prior peak in spreads in October of last year?

Hey Jason, it's Brian. Yes, I think spreads are pretty consistent with previous widening episodes. So, certainly, the environment or at least I'm sorry, the opportunity is attractive in mortgages. I do think that the reason that we feel a little less comfortable from a leverage perspective is that with the potential reinvigoration of inflation that it could cause further delays in monetary policy adjustment, which right now, the market is pricing in. I think it's close to three. I know it just shifted a little bit yesterday after the Fed meeting, but three cuts in 2025. We do think that there's a risk that there's fewer than that. And mortgages may not respond all that well to a shift into zero cuts or potentially even pricing in hikes. So, we do think that being a little bit more conservative relative to where we were maybe last fall when the prospect of hikes were -- or of zero cuts was much less.

Got it. That's good color. And as a follow-up, I see that you've been -- for three quarters now, you've been reallocating your spec pool exposure away from the low loan balance and into more credit constrained. Can you talk about how you see the relative value there? Is it just a function of pricing? Is there some other risk to loan balance pools that you're seeing?

Yes, it's a couple of different things, Jason. It's First of all, yes, I mean, loan balance pools are certainly kind of the premier spec pool story out there. So because of that, they tend to be pretty fully priced. Now you do get prepayment certainty out of that. So, there is a benefit to paying up for that. But with -- like I said, with increased economic uncertainty and potential slowdown, we do think that kind of those lower FICO pool borrowers, we could see increased demand for that and potentially slower housing HBA as well. So LTV stories also kind of makes sense from that perspective. But kind of the second portion of that is it's generally our rotation from lower coupons into higher coupons. Most of our lower coupon holdings were in loan balance. as opposed to as we're rotating into higher coupons, we want to have a little bit less spec pool pay-up exposure. So, it's partly just maintaining a little bit lower profile from a payout perspective.

Got it. That’s actually very helpful. Thanks for the time guys.

Our next question now is from Jason Stewart with Janney. Your line is open.

Hey thanks. Good morning. I wanted to follow up on your comments about the forward rate outlook. Are you in the camp where it's sort of either six or seven cuts if we have a recession, no cuts if we don't? Maybe like if you could give us some comments on how you're thinking about that in relation to how you develop the hedge portfolio, that would be helpful.

Hey Jason, it's Brian. Yes, thanks. Yes, I think listening to Chair Powell yesterday, the takeaway was just greater uncertainty about policy going forward. It's kind of a wait-and-see approach, whether we still see strength in hard data, while soft data is certainly pretty weak. So it's just a matter of the timing on when those two converge and how they converge. I think like I said, there's about three cuts being priced in for 2025. We see a fair amount of economists out there saying 0 cuts and a fair amount saying that they're going to have to be pretty aggressive. So I think in that environment, our goal is to just be conservative and keep things close to home, both from a hedge notional ratio perspective as well as leverage because if things were to swing in either direction, that could -- you could be offsets.

Okay. Fair enough. So, no strong view either way on which way we're headed.

No, we don't like to take interest rate risk in the REIT. So we try to keep duration gap pretty close to 0. We may be leaning slightly towards a steeper curve, but not a significant.

Okay. Got it. That's helpful. And then in terms of the ATM activity, I'm coming up with about $8.55 a share on issuance. Could you give us a sense for your estimate on the impact to book value in 1Q from ATM issuance and where you're comfortable issuing going forward?

Yes, I think given where spreads are, we feel like the investment environment is attractive enough. I think that's probably about right from a share price perspective. So, the impact would have been pretty modest -- but again, given where we're able to put money to work, we think overall, it's certainly improving the economics of the REIT and to shareholders. And also issuing through the ATM helps us reduce expenses.

Okay. Thanks. Appreciate the color and taking the questions.

Thank you. [Operator Instructions] Presently, my last question now is from Eric Hagen with BTIG. And your line is open.

Hey thanks. Good morning. Good discussion here around the Fed. I guess I have one follow-up. Like our mental framework has typically been for mortgage spreads to tighten if the Fed cuts interest rates, and I feel like that's probably still the case. But do you think that's different or has the potential to be different in this environment because of the macro and its impact on just the flow of capital? And should we necessarily take a Fed cut as being a catalyst for spreads to tighten? Or how do you think about that?

Yes. Hey Eric, thanks, it's Brian, and I hope the conference is going well. Sorry, we couldn't be there. But yes, I think that generally speaking, that's correct. A slowing economy should lead to a steeper curve, which helps agency mortgage valuations. I also think in the near-term here, a Fed on hold isn't necessarily a bad thing for mortgages. It does reduce short-term volatility. So, mortgages could do okay here with the Fed kind of taking a wait-and-see approach. But no, I think a slowing economy does -- it certainly helps mortgages versus other credit assets. And versus treasuries, I think they hold in just fine and then are poised to do pretty well as kind of as other asset classes kind of start to catch up as the economy maybe comes off of the slowdown and starts improving again.

Great. All right. Thanks for the color. Are you guys seeing any opportunities in commercial credit and maybe picking up some more share there? And how you guys think about relative value versus RMBS right now? Thank you guys.

Yes, I mean we've been relatively hesitant to add credit exposure in this environment. I think certainly, we are not interested in financing versus with mark-to-market financing. So, we haven't been looking to add. We actually have sold our remaining credit investments that were pretty modest coming into the year, but we're completely out of those and found fairly decent levels to get out of those. So, we're 100% agency at this point, and we don't anticipate that changing in the near-term.

Got you. Thank you guys.

Thanks Eric.

Thank you. As I have no further questions in queue, I would like to turn it back to management for any closing remarks.

No. We'd just like to thank everyone for joining us this morning and we look forward to getting together again next quarter. Thanks.