IVR - NYSE

Welcome to the Invesco Mortgage Capital Fourth Quarter 2025 Earnings Call. [Operator Instructions] As a reminder, this call is being recorded. Now I'll turn the call over to Greg Seals, 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 appropriate reconciliations to GAAP. Finally, Invesco Mortgage Capital is not responsible for and does not edit nor guarantee the accuracy of our earnings teleconference transcripts provided by third parties. The only authorized webcasts are located on our website. Again, welcome, and thank you for joining us today. I'll now turn the call over to Invesco Mortgage Capital's CEO, John Anzalone. John?

Good morning, and welcome to Invesco Mortgage Capital's Fourth Quarter Earnings Call. I will offer brief remarks before turning the call over to our Chief Investment Officer, Brian Norris. Joining us for Q&A are President, Kevin Collins; COO, Dave Lyle; and CFO, Mark Gregson. Financial conditions improved during the quarter, supported by 2 Federal Reserve rate cuts, solid corporate earnings, improved financial conditions and strong economic growth. Equity markets extended their gains, credit spreads remained tight and agency mortgages outperformed treasuries, aided by lower rate volatility in a supportive supply and demand environment. Inflation readings trended modestly lower during the quarter with headline CPI at 2.7% and core CPI at 2.6%. Investors responded by reducing inflation expectations, reflected in lower breakeven rates on inflation-protected treasury bonds. Even with continued economic growth, the U.S. labor market continued to exhibit weakness as the economy lost 67,000 jobs during the quarter. Despite inflation running above target, the FOMC cut the federal funds target rate by 25 basis points at each of its last 3 meetings in 2025, citing labor market weakness. The Federal Reserve also ended its quantitative tightening program after reducing its treasury and agency mortgage holdings by more than $2.2 trillion since mid-2022, specifying that mortgage paydowns will be reinvested into treasury bills going forward. Markets are pricing in an additional 50 basis points of cuts through 2026. Interest rates were generally stable during the quarter and the decline in interest rate volatility that began after the sharp increase in April continued into year-end. With market expectations shifting towards a more accommodative monetary policy stance, agency mortgages delivered its strongest calendar year performance relative to U.S. treasury since 2010. Key drivers included a decline in interest rate volatility, broad inflows into fixed income and increased demand from Fannie Mae and Freddie Mac's investment portfolios. Agency CMBS spreads finished the year slightly tighter as markets gained confidence in the path towards monetary policy easing and improved clarity in U.S. trade policy. Higher issuance levels are readily absorbed given money manager inflows and continued bank demand for assets with stable cash flows. These factors led to a 3.7% increase in our book value per common share to $8.72 and combined with our recently increased dividend of $0.36 resulted in an 8% economic return for the quarter. We modestly increased leverage to 7x, consistent with the constructive investment environment. At year-end, our $6.3 billion portfolio included $5.4 billion in Agency mortgages, $900 million in Agency CMBS and our liquidity position remained robust with $453 million in unrestricted cash and unencumbered assets. We remain positive on agency mortgages following the sharp decline in volatility, though we view near-term risks as balanced given recent strong performance and the announcement of $200 billion in agency mortgage purchases by Fannie Mae and Freddie Mac. Agency CMBS continues to provide attractive risk-adjusted yields and diversification benefits. Longer term, we believe conditions for agency mortgages will remain favorable given lower interest rate volatility and expectations for broadening demand and a steeper yield curve. I'll now turn the call over to Brian for additional detail.

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 markets over the past year. As depicted in the chart on the upper left, despite 2 25 basis point cuts to the Fed funds rate during the fourth quarter, the 10-year treasury yield was largely unchanged, increasing less than 2 basis points to end the year at 4.17%, 40 basis points lower than where it started the year. Although 10-year yields were relatively stable over the quarter, the yield curve continued to steepen meaningfully with 2-year treasury yields falling 14 basis points, while 30-year yields increased 11 basis points. The difference between 2-year and 30-year treasury yields ended the quarter at 137 basis points. 83 basis points steeper than a year ago. The steeper yield curve benefits longer-term investments such as Agency RMBS and Agency CMBS and is supportive of our strategy. The chart in the upper right reflects changes in short-term funding rates over the past year, with the fourth quarter highlighted in gray. While financing capacity for our assets remained ample and haircuts unchanged, 1-month repo spreads began to indicate broad-based funding pressures in late September and continued into October, widening approximately 5 basis points. Positively, the Fed's decision to end quantitative tightening in December alleviated the pressure and its announcement at the December meeting to initiate purchases of shorter-term treasury securities as needed to maintain an ample supply of reserves led to notable improvement in repo spreads as we head into 2026. Lastly, the bottom right chart on Slide 4 highlights the significant decline in interest rate volatility since April, which provided a tailwind for risk assets, including Agency MBS in the second half of the year. Although we do not anticipate further declines in 2026, the current level of volatility is in line with longer-term averages and remains supportive of the Agency RMBS sector. 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 fourth quarter in gray. Agency mortgages delivered strong performance both for the quarter and the full year, driven by reduced interest rate volatility that kept money manager and mortgage REIT demand robust, while net supply remained below expectations. Two additional cuts to the Fed funds rate, the end of quantitative tightening and the beginning of monthly T-Bill purchases by the Federal Reserve, all announced during the fourth quarter, provided significant support for risk assets in general and agency mortgages in particular, as funding markets improved notably. Although bank and overseas purchases remain subdued, increased demand from the GSEs provided additional support, resulting in strong returns for the sector. Net GSE purchases began to increase late in the second quarter and accelerated in the second half of the year, providing notable support for agency mortgage valuations. Not only did the unexpected demand provide an immediate lift to valuations, but it also strengthened expectations that the GSE's retained portfolios could serve as a stabilizing backstop for the sector, helping to reduce spread volatility going forward and providing support that the agency mortgage market has lacked since Federal Reserve and bank participation waned in 2022. This supply and demand environment also helped support the TBA dollar roll market, as you can see in the lower right chart. Implied financing improved notably during the quarter, whereas for most of 2025, financing via the dollar roll market was relatively unattractive compared to funding via short-term repo markets. As illustrated, that advantage narrowed late in the quarter and the shift is indicative of strong demand for agency mortgage collateral amid limited net supply. As this environment persists, the sector becomes more attractive, allowing investors to fund purchases at implied levels significantly below short-term funding rates. Lastly, 30-year mortgage rates declined modestly to end the quarter near 6.25% as tighter mortgage spreads offset slight increases in the 10-year treasury yield and primary secondary spread. This decline in mortgage rates continue to weigh on the performance of higher coupons relative to those lower in the coupon stack with discount coupons modestly outperforming premiums as investors were reluctant to increase prepayment risk in their portfolios. In the upper right-hand chart, we show higher coupon specified pool pay-ups, which are the premium investors pay for specified pools over generic collateral and are representative of the bonds that IVR owns. Positively, pay-ups improved during the quarter, offsetting some of the underperformance of higher coupons relative to lower coupons given increased investor demand for additional prepayment protection in premium dollar priced bonds. We continue to believe that owning prepayment protection via carefully selected specified pools, particularly in premium-priced holdings, remains an attractive investment for mortgage investors and helps mitigate convexity risk inherent in agency mortgage portfolios. Slide 6 details our Agency RMBS investments as of year-end. Our Agency RMBS portfolio increased 11% quarter-over-quarter as we invested proceeds from ATM issuance and paydowns and modestly increased leverage as the investment environment for agency mortgages improved. Purchases were primarily focused in 5% and 5.5% coupons with a decline in our 6% and 6.5% allocation, a result of paydowns and the overall growth in the portfolio. Although we continue to focus our specified pool allocation on prepayment characteristics that are expected to perform well in both premium and discount environments, price appreciation in our holdings has resulted in a higher percentage of our pools valued at premium dollar prices. Therefore, we continue to favor specified pools with lower loan balances, particularly in our higher coupon exposures given their superior predictability of future cash flows, while we remain well diversified across collateral stories with limited changes during the quarter. Overall, we remain constructive on Agency RMBS as supply and demand technicals are favorable and lower levels of interest rate volatility should continue to encourage demand for the sector. We believe near-term risks are balanced following recent outperformance with nominal spreads tightening approximately 15 basis points during the fourth quarter and another 10 basis points year-to-date. Despite the decline in risk premiums, levered returns on Agency RMBS hedged with swaps remain attractive with the current coupon spreads to 5- and 10-year SOFR blend ending the year near 140 basis points, equating to levered gross returns in the mid- to upper teens. Slide 7 details our Agency CMBS portfolio. Risk premiums were largely unchanged during the quarter as higher issuance levels were well absorbed via money major inflows and continued bank demand for stable cash flow profiles. Given more attractive relative value in Agency RMBS, we did not add to our Agency CMBS position during the quarter, and our allocation declined modestly due to the growth in the overall portfolio. Despite the lack of new purchases, we continue to believe Agency CMBS offers many benefits, mainly through its inherent prepayment protection and fixed maturities, which reduced our sensitivity to interest rate volatility. Levered gross ROEs are in the low double digits and consistent with ROEs and lower coupon Agency RMBS. We have been disciplined in adding exposure only when the relative value between Agency CMBS and Agency RMBS accurately reflects their unique risk profiles. Financing capacity has been robust as we continue to fund our positions with multiple counterparties at attractive levels. We will continue to monitor the sector for opportunities to increase our allocation to the extent relative value becomes attractive, recognizing the overall benefits to the portfolio as the sector diversifies risks associated with Agency RMBS. Slide 8 details our funding and hedge book at quarter end. Repurchase agreements collateralized by our Agency RMBS and Agency CMBS investments increased from $5.2 billion to $5.6 billion, consistent with the increase in our total assets, while the total notional of our hedges increased from $4.4 billion to $4.9 billion. Our hedge ratio was relatively stable during the quarter, increasing slightly from 85% to 87% as market expectations for monetary policy in 2026 were largely unchanged during the quarter. The table on the right provides further detail on our hedges at year-end. The composition of our hedges remained weighted towards interest rate swaps with 78% of our hedges consisting of interest rate swaps on a notional basis and 57% on a dollar duration basis. Swap spreads widened during the quarter, serving as a tailwind for our performance. Despite the recent widening, we remain comfortable focusing the majority of our hedges in interest rate swaps as we continue to believe swap spreads are historically tight and offer an attractive hedge profile relative to treasury futures. To conclude our prepared remarks, financial market volatility declined notably in the second half of 2025, resulting in strong performance for agency mortgages. IVR's economic return of 8% during the fourth quarter is a result of that positive momentum, which has continued into 2026 with book value up approximately 4.5% since year-end through Wednesday of this week. While agency mortgage valuations have improved significantly over the past year, we believe the current environment is reflective of a more normalized investment landscape that continues to provide investors with attractive levered returns. The January announcement of the MBS purchase program by the GSEs was well received by the market and the reduction in interest rate and spread volatility has broadened the investor base and enabled modestly higher leverage. The conclusion of quantitative tightening in the fourth quarter, along with announced T-Bill purchases by the Fed helped solidify funding markets and tightened repo spreads, serving as another tailwind for our strategy. Lastly, we believe our liquidity position provides substantial cushion for any potential market stress while also allowing sufficient capital to deploy into our target assets as the investment environment evolves. While we view near-term risks as somewhat balanced, we believe the current environment of low volatility in interest rates and spreads, along with further steepening of the yield curve and supportive supply and demand technicals will provide a positive backdrop for agency mortgages over the long term. Thank you for your continued support of Invesco Mortgage Capital, and now we will open the line for Q&A.

[Operator Instructions] Our first question comes from Trevor Cranston with Citizens JMP.

I think in the prepared comments, I heard you characterize your view on MBS post the GSE buying announcements as a little more balanced. Can you talk about how you're approaching the leverage level post the tightening that's occurred and kind of where you guys are finding value within the coupon stack with marginal deployments today?

Trevor, it's Brian. Yes, so we did take leverage up a little bit in the fourth quarter, just reflective of that positive environment that we've continued to kind of see in the second half of the year. And so I think we're still relatively comfortable there. I think with the announcement with spreads a little bit tighter, we do kind of let leverage drift a little bit. So as book value increases, leverage could come down just a little bit. But I think we're still pretty comfortable because the environment overall, even though spreads are tighter, it's pretty supportive with limited spread volatility. As far as the coupon stack goes, I think I mentioned that there's been some notable improvement in the TBA dollar roll market. And that's really been across the coupon stack, but primarily in the belly, so call it 3.5 through 5.5s. And so I think we're finding pretty good value in those securities.

Got it. Okay. And I was curious within the specified pool portfolio, particularly in higher coupons, if you guys have seen any surprises within prepaid reports or if things have kind of behaved pretty much as you expected them to?

Yes, I wouldn't necessarily say that we've seen any surprises. We certainly saw an increase over the second half of the year in higher coupons in our 6s and 6.5s, prepayment speeds did increase. But because we do own prepaid protection, they certainly were less impacted than what you would see in generic collateral. Loan balance continues to, like I said in the prepared remarks, continues to be superior predictability of cash flows, and we continue to feel that way. I think certain FICO and LTV and even geo stories, a little bit less so, but still relatively in line with expectations heading into it.

Our next question comes from Jason Weaver with JonesTrading.

Maybe just to tee off of Trevor's first question there. Year-to-date, with new capital invested, have you continued rotating down in coupon? And maybe you can talk a little bit about the trade-off you see between elevated prepay risk and the positioning in some of those 5.5 and 6 pools.

Sure. Yes. Jason, it's Brian. Yes, I think certainly, there is a push by the administration on housing affordability, and they are directly focused on the mortgage rate and bringing that down. So to the extent that, that impacts higher coupons, I think the goal is likely to not necessarily reduce the allocation by selling, but to future purchases come a little bit lower in the coupon stack. So like I said earlier, more belly and lower coupons. Like I said, the TBA dollar roll market is pretty attractive in those coupons right now. So that's providing a nice boost as implied funding levels are significantly below SOFR.

Got it. And the only other thing is, did you give an updated estimated book value as of today?

I did say we were up about 4.5% through Wednesday.

Yeah you did, right. I missed that one, but I appreciate the color. Thank you.

Our next question comes from Doug Harter with UBS.

You continued kind of modest capital actions in the quarter, some small common issuance and some small preferred buyback. Can you talk about how you're thinking about capital structure and kind of the ability to raise capital going forward?

Yes. Doug, it's John. Yes, I think in terms of capital structure, we feel like we're in a better place than we've been. It's been improving. So that's -- we're happy about that. As far as the ATM goes, we do selectively access the ATM when the common stock provides clear benefits to shareholders. And we continue to view the ATM as the most efficient mechanism for raising capital. It was a pretty modest issuance during Q4 and conditions were slightly better in -- have been better in Q1. So you'll get an update later this month or actually in February when we report our monthly dividend, we'll provide more color on that.

[Operator Instructions] Our next question comes from Jason Stewart with Compass Point.

Just following up on the capital raising, just putting it in context with the investment environment. Is the decision on the ATM solely where the stock is? Or is part of this equation, what the pro forma ROEs look like? And on that front, would additional government action like an increase to the limit of the GSEs or removal of the PSPA cap or like a standing repo facility change your view of a spread range for MBS and change your view of capital raising on the second half of that?

Yes. I'll start with the first part, and I'll let Brian tackle the harder part, second part. I think it is a combination of things when we make a decision on whether to issue. I mean it obviously price to book is important. I mean that's the first metric. And then after that, it's other accretive investment opportunities. And so we tend to look at it as through the prism of how long is the payback period in terms of, okay, we're making accretive investments. And if we're trading slightly below book, we need accretive investments. If you're trading above book, you'd like to have accretive investments. But. Yes, I mean, that's how we kind of look at it. It's a combination of those 2 things. And then the second part of the question.

Yes. I would just add to that just -- this is Brian, Jason. Yes. I would just add, those are certainly kind of more quantitative aspects of it. There is a qualitative aspect as well, just, I guess, even economies of scale on reducing expenses, improving liquidity in the stock. Those are all things that kind of go into the factor on whether we are using -- utilizing ATM or not. As far as available ROEs, I did mention as of year-end, spreads versus SOFR were still pretty attractive around 140. We've seen about 10 basis points of tightening since then. So knock 1% or 2% off the available ROEs that we're seeing. But I think with the presence of the GSEs being more substantial now and being more prescriptive, that does help reduce volatility, brings greater comfort into potentially higher leverage. So I think there's a lot of positive things that despite slightly lower ROEs that there's a lot of reasons to kind of like the space right now.

Yes. Okay. That's helpful. But on the government intervention side or the presence of GSEs, is there anything that would sort of get you to the next level where it's less of a backstop view and more of the view that it's a tighter spread range and a lower spread range?

Yes, lower than where we are now?

Yes.

Yes. Certainly, if there was an announcement that they increased the caps from currently to $450 billion. That would be a signal. And maybe as we move along here throughout the year, if we start to see that the pace of purchases has increased notably. I think in December, the GSEs added a combined $24 billion between loans and mortgages, agency mortgages. So I think if we were to see that pace continue to increase, that would be a pretty clear signal that at some point, the administration or the treasury and the FHFA plan to increase those caps. And so that could potentially take us into another spread regime and take us another 10 to 15 basis points tighter from here.

And our last question comes from Eric Hagen with BTIG.

All right. So spreads have already tightened a lot. How should we think about the book value sensitivity and just like the overall upside to further spread tightening? Like would you say that the sensitivity or the magnitude is kind of similar as when spreads were relatively wider? Or how should we think about the magnitude because of the fact that spreads are kind of reset tighter?

Eric, it's -- sorry, didn't mean to cut you out there. I would say the magnitude of the change in book value to spread changes is the same, just given that our leverage is relatively in line with where it has been here recently. But our expectation for further spread tightening is significantly reduced. And so we kind of -- we saw a lot of spread tightening in 2025. We certainly would not expect that to occur unless there are, again, like I just mentioned, significant changes in the caps for the GSEs and their use of those retained portfolios. So we're not really expecting significant spread tightening from here. The $200 billion of purchases is largely priced into the market as we sit here today. So unless we start to see banks come in, in greater size and also increased caps. We don't necessarily expect spreads to tighten much. The expectation is that the longer we kind of stay at these spread levels, we'll see kind of money managers start to sell a little bit into it and kind of keep us here as opposed to taking us tighter.

And at this time, I'll turn the call back over to the speakers.

Okay. Well, thank you, everybody, for joining us, and we will talk to you next month. Thank you.