Tony Semak - IR Rich King - CEO Lee Phegley - CFO Rob Kuster - COO John Anzalone - CIO.

Douglas Harter - Credit Suisse Bose George - KBW Brock Vandervliet - Nomura Securities Mark DeVries - Barclays Trevor Cranston - GMP Securities.

Good morning, ladies and gentlemen, welcome to Invesco Mortgage Capital's First Quarter 2016 Investor Conference Call. [Operator Instructions] As a reminder, this call is being recorded. Now I'd like to turn the call over to Mr. Tony Semak in Investor Relations. Mr. Semak, you may begin the call..

Thank you, Hans, and good morning, everyone. Again, we really want to welcome you to the Invesco Mortgage Capital first quarter 2016 earnings call. I'm Tony Semak with Investor Relations and our management team and I are very delighted you joined us.

We're really looking forward to sharing with you our prepared remarks, which we always do, during the next several minutes, before we conclude with a question-and-answer session.

Joining me today are Rich King, Chief Executive Officer; Lee Phegley, Chief Financial Officer; John Anzalone, Chief Investment Officer; and Rob Kuster, Chief Operating Officer. Before we begin, I'll provide the customary forward-looking statements disclosure and then we will proceed to management's remarks.

Comments made in the associated conference call may include statements and information that constitutes forward-looking statements within the meaning of the U.S. securities laws, as defined in the Private Securities Litigation Reform Act of 1995. And such statements are intended to be covered by the Safe Harbor provided by the same.

Forward-looking statements include our views on the risk positioning of our portfolio, domestic and global market conditions, including the residential and commercial real estate market.

The market for our target assets, mortgage reform programs, our financial performance, including our core earnings, economic return, comprehensive income and changes in our book value.

Our ability to continue perform it's trends, the stability of portfolio yields, interest rates, credit spreads, prepayment trends, financing sourcing, cost of funds, our leverage and equity allocation.

In addition, words such as believes, expects, anticipates, intends, plans, estimates, projects, forecasts and future or conditional verbs such as will, may, could, should and would, as well as any other statement that necessarily depends on future events, are intended to identify forward-looking statements.

Forward-looking statements are not guarantees and they involve risks, uncertainties and assumptions. There can be no assurance that actual results will not differ materially from our expectations.

We caution investors not to rely unduly on any forward-looking statements and urge you to carefully consider the risks identified under the captions Risk Factors, Forward-Looking Statements and Management's Discussion and Analysis of Financial Conditions and Results of Operations in our Annual Report on Form 10-K, and Quarterly Reports on Form 10-Q which are available on the Securities and Exchange Commission's website at www.sec.gov.

All written or oral forward-looking statements that we make or that are attributable to us are expressly qualified by this cautionary notice. We expressly disclaim any obligation to update the information in any public disclosure and if any forward-looking statement later turns out to be inaccurate.

In our call this presentation is available on our website and the audio replay can be accessed through May 24, by dialing 800-95-1940 or for international callers 1-402-998-1654. Again we welcome you and thank you so much for joining us today. We will now hear from our Chief Executive Officer, Rich King..

Thanks, Tony. And good morning, ladies and gentlemen, appreciate you joining today. So we'll start Slide 3 of the deck. In the first quarter Invesco Mortgage Capital earned core income of $0.44 and in the quarter we declared a $0.40 dividend.

Core earnings benefited during the quarter from multiple sources including reduced interest expense on our hedging book favorably slow, prepaid speeds and accretion from share repurchases. In the first quarter we continue to reduce the size of the portfolio. Both asset balances and repurchase agreement financing balances.

And so duration hedging needs declined as well. Therefore, we've continued to reduce interest rate hedges and still have maintained our overall low equity duration.

As for the reduced asset balances, we chose to sell lower ROE assets with shorter durations because we are positive on credit conditions and wanted to maintain upside from spread tightening.

We reduced hedging cost by taking off primarily shorter swaps that would not help us a great deal in terms of interest rate protection, given that we believe Invesco is going to move cautiously for this year at a minimum. Book value declined 3.6% in the first quarter due to credit spread movements.

Given the spread widening in Q1, our economic return that is the change in our book value plus dividends phase was slightly negative at minus 1.2%. The good news there is when book value declines like that due to spread widening; it doesn’t leave any permanent mark.

Book values come back when spreads come back and by the way, they already have and we estimate that our book value per share now is about where we started the year, so up about 3.5%. We think in the slow rate environment with slow but steady economic growth, credit spreads are going to end up tighter over time. Historically, that's what happens.

The longer we stay to give them level or grades, spreads get tighter. The volatility we saw in the first 6 weeks of the quarter, have subsided the financial condition have improved and the outlook is favorable now. In April we gained back, like I said, about - I think in April like 3% and then the rest since then here in May.

I’m very pleased with the way the Company responded to the volatility. The changes we have made over the past few years to reduce book value volatility are really paid dividends front intended, and we will likely repurchase stock, and we will be opportunistic and buy shares when that's in the best use of capital.

So we are optimistic about economic return and about our stocks performance for 2016. In the quarter we funded four CRE loans totaling $70 million roughly and in a short - in a quarter where we had limited time to operate in the open period, we bought back $25 million of our shares.

Over the past three quarters, I think, we’ve now bought back close to 10% of our outstanding shares. So with that, let's turn to Slide 4 in the presentation and talk more specifically about the Q1 book value. So, as I mentioned, the first quarter was a volatile environment for financial markets.

The credit spreads widened in January and early February and then recovered to end only modestly wider. But in early February, the volatility was significant and the credit plus liquidity risk reprised in a correlated fashion.

The quarter actually ended with, like I said spreads only non-only wider but rates ended the quarter significantly in lower despite that recover in spreads. And falling rates in Q1 caused temporary reduction and a component of book value due to our swap hedges and we labeled those derivatives on the page by $1.86 per share.

The market yields on our assets sale also along with risk-free rates by less than swaps and that constitutes the spread widening and the assets were hedging predominantly on the chart here labeled as agency MBS and CMBS together contributed $1.23 to book value, so less than the hedges cost us at $1.86.

Our residential portfolio as little duration and with weaker spreads, the contribution to book value was to take book value down $0.11. On the positive side, we accredited about $0.09 of book value from share repurchases. Obviously, we paid out most of our core income of $0.44 via the $0.40 dividend.

So we are in a good place going forward with an attractive dividend, strong improving asset quality, low interest rate risk and declining book value volatility. We are positive on credit spreads and credit fundamentals as well.

And we also see that with increased regulations on the length of securitization, we are well positioned to be in a opportunity to capture some trades that work for private capital and earn attractive returns and continue to reduce leverage.

With that, I’m going to turn it over to John Anzalone our CIO who will now tell you about our portfolio and strategy..

Thanks Rich, and thanks again to everyone joining us on the call this morning. I’ll start with Slide 6. As you can see from the pie chart, our portfolio is still well-diversified with 66% of our equity allocated to credit and 34% allocated to agency mortgages.

While we kept our overall sector allocation fairly stable compared to last quarter, we did shift equity to commercial real estate loans. If these loans are held unlevered, they consume more capital than bonds that we financed. As such, we sold lower yielding assets in each sector to fund these loans, as well as to fund share repurchases.

Accordingly, we also un-round swaps that rolled down the curve and were no longer providing much protection from changes in rates. The portfolio experienced some pretty significant spread-widening during January and February. We saw that trend largely reversed in March and April leaving spreads roughly unchanged in year end.

I want to reiterate Rich's point that we view volatility and spreads on high quality assets as a temporary phenomenon. And given the solid fundamental backdrop in both residential and commercial real estate, we expect the credit spreads will continue to be well supported.

While we like high quality credit, we continue to position the company conservatively with regard to interest rate risk. In fact, empirical duration of the portfolio continues to hover around zero, meaning that changes in interest rates have not had a meaningful impact on book value.

We think this is important because we have a large interest rate exposure, the cost of constantly resetting hedges, becomes more expensive as rate volatility increases. But take a closer look at each sector starting with agency mortgages on Slide 7.

We kept the allocations within our agency book relatively stable this quarter and our focus continues to be on balance back by collateral with shorter duration profiles and stable cash flow characteristics.

As you can see on the chart, we’ve done this through a combination of hybrid ARMs, 15 year collateral, and higher coupon well-seasoned, specified to a 30 year paper. Prepayments moderated during the quarter as we hit the seasonal lows in January.

We’ve since seen spreads increase with the March trend, and given lower mortgage rates and increased seasonal housing activity, we expect speed to remain somewhat elevated over the next several months. Let’s move on to residential credit starting on Slide 8. Our residential book is made up of 60% legacy paper and 40% new issue bonds.

Fundamental still is positive as limited inventory and low mortgage rates support home prices. Additionally, a strengthening labor market and favorable demographic trends are helping to drive an increase in housing demand.

Spreads were mixed during the quarter with legacy paper ending the quarter a touch weaker, and here key bonds rallying sharply emerged, closed the quarter slightly higher. But right now, the duration profile of our residential credit book in the table at the bottom of the slide.

With the exception of new issue RMBS at 1.5 years, the average duration for the various asset classes is less than half year meaning that this part of the portfolio is well insulated from interest rate risk. On Slide 9, we provide an update on the credit quality of our residential portfolio.

The chart in the left shows that over 65% of our non-agency holdings have dollar prices above 90. This is important because high dollar priced bonds have limited exposure to collateral performance issues, lower price volatility and are generally more attractive to finance. The chart in the right breaks out the vintage data for the various sectors.

The legacy paper is focused in Prime and Alt-A securities as well as senior Re-REMICs. These all represent bonds that are at the top of the capital structure. The GSE credit risk transfer bonds are largely 2013 and 2014 vintages.

These bonds reference loans with significant embedded home price appreciation and the season transaction tend to demonstrate lower price volatility compared to more recent issuance. On Slide 10 we show breakout of our commercial credit portfolio. The legacy portion continues to pay off, the portfolio is now dominated by close crisis paper.

The single-A and BBB paper was issued in 2013 or earlier and benefits from collateral appreciation as well as strong underwriting. AA and AAA paper benefits from higher subordination levels and enjoys favorable financing. Fundamentals remain strong as favorable trends in rents and occupancy rate support the market.

Credit spreads are quite volatile during the quarter widening earlier in the quarter and recovering most of the widening by quarter end. Additionally we closed 40 commercial loans totaling $70 million during the quarter which brings us to Slide 11. Slide 11 is a breakout of our commercial loan investments.

I won't go through all the details on the slide but the important highlights are the portfolio was $317 million at quarter end. We had $112 million of principal return through the realization of borrowed business plans. We experienced no delinquencies and the weighted average LTV of the portfolio was 66% at quarter-end.

We've made mezzanine investments behind five different balance sheet lenders and the portfolio is diverse both geographically as well as by property type. On Slide 12 we give a picture of the credit quality of our commercial credit. On our CMBS portfolio the average LTV is 36% and as I just mentioned the LTV on our CRE book is 66%.

This shows the vintage breakout of our CMBS portfolio on the right, this shows that 95% of the loans, backing our bonds were originated in 2014 or earlier and these benefits from notable property price depreciation.

Finally on Slide 13, we give some highlights of our financing, financing remains stable through the quarter with cost of funds modestly higher in line with the December rate hike. That's it for our prepared remarks. We would like to open the line for our Q&A..

[Operator Instructions] And our first question is from Douglas Harter from Credit Suisse. Sir, your line is now open..

Thanks.

Rich or John, can you talk about how would your interest rate exposure looks today sort of compared to last quarter given some of the swap repositioning you talked about?.

Yes, this is John. It looks very similar. I mean we run our empirical durations and you know we still see very little correlation to rates to whatever position right now. So lot of the swaps that we took off has rolled down the curve, you know most of them were inside of the year last and so weren't really providing a whole lot of protection anyway.

So you know taking them off didn’t really impact our industry position..

Great.

And given your comments that spread of fully tightened and book value is fully recovered, I guess how do you see return and the return environment for new investments compared to repurchasing your stock?.

On share repurchases that's kind of going to depend on where the stock is obviously during the quarter and we look everyday at what our opportunities are and where the stock price is. And you know I think it's likely that we will continue to buy back shares during the quarter.

As far as the return opportunities, yes with the tightening that's been probably high single digit to low double digit on most securitized opportunities.

And maybe with the exception of risk sharing which is somewhat higher and obviously the commercial loans will continue to look to be in the market there and look for opportunities to buy the bottom of the capital stack partnering with this year's in the CMBS space under the new risk retention rules which we expect to start seeing deals pretty soon..

Great, thanks Rich..

Thank you. And our next question is from Bose George of KBW. Sir, you may now ask your question..

Hi guys, good morning. Actually just a follow up on that, the question about incremental investments.

So could you just kind of go through the different buckets and sort of highlight what's the most attractive areas in terms of ROEs?.

Yes, so in terms of - on the bond side I think within agencies we're favoring 15 years both from a shorter duration profile and evaluation basis versus hybrids. As Rich said, I think most of the sectors are going to be kind of low double digits at or around 10% ROE. So i.e.

favorite 15s, here key bonds we have not been adding recently, you know that's been a pretty volatile sector but I think we’re beginning to get a little bit more comfortable. We have seen some positives in that market over the last couple of quarters. We have seen trading volumes have increased which has been really notable for the sector.

There are new issue deals that have been pretty well received, fundamentals were good, we saw our first upgrade, so we’ll be having more positive on that story. The bad news is that ROEs have tightened in. We went from probably solving mid double digit - 15 call it ROEs into maybe 10 to 12 type ROEs on CRT.

And then in CMBS again its same kind of story, I mean its lower double digit type ROEs.

We have been less active there because we're not as positive on the underwriting that’s occurred more recently although we do expect to see underwriting improve over the course of the year as some of the regulations come in and issuers have to get in the game with the risk retention rules.

So we do expect to see an improvement in underwriting, and we will probably wait to start seeing that materialize before we getting involved in that market..

Okay, great, that’s helpful thanks.

Then in terms of the performance of the commercial book this quarter, between the two big buckets that you have the AAAs, and double BBB, was the performance pretty similar, the widening and then the coming back in or did one sector perform meaningfully different?.

Yes, the lower rate was definitely saw more volatility as you'd expect. But they both, I think they both had the same trend, they widened in January, February, then came back since, but I’d say you know BBB is definitely – A, BBB definitely had a little bit more volatility..

So some of the gain that you guys had in the quarter was really from the AAAs, right?.

Yes, that’s right. .

Okay, great.

Actually just one more on prepayments, in terms of the prepayment outlook for the next couple of quarters you mentioned the expected increase, do you sort of quantify that in terms of what you might expect?.

Yes, we had the first quarter prints which you can see on the slide but then the beginning of April we had our March pre-paid print and that was up probably 2 or 3 CVR, something in that range, percentage wise it is pretty big because it’s only off of a pretty low double digit number, it’s like 20% or 30% something like that.

So we expected to stay kind of in that mid - kind of mid teens over the next couple - probably the next quarter or two but just being typical as we hit spring seasonals and then we would expect, obviously it’s going to be dependent on rates just general level of rates.

But if rates stay around here, we would expect speed to stay elevated for a quarter or two and then starts to trail off as we hit summer or get into summer I should say..

Okay, great. Thanks a lot..

Thank you. And we now have a question from Brock Vandervliet of Nomura Securities. Sir, your line is now open..

Thanks for taking the question. I was just wondering if you could talk more about risk retention and how that may impact the playing field in CMBS. We've seen I guess one deal where in the residential space, the mortgage rate was able to buy the subordinate piece of third party transaction.

Is that what you are expecting to see in CMBS as well?.

I think we are really not sure what sort of form it’s going to take yet in terms of what structure it’s going to look like. Whether they're going to vertical slices or horizontal slices, in terms of that 5% risk retention. So little bit uncertain on what it’s going to look like. But we do expect that we will have opportunities like that going forward.

I mean, we just haven’t seen it yet..

I’d just add that we think that really no matter the outcome of what ends up being the most attractive to issuers that there will be increased opportunities for us because typically, the BPs buyers really didn’t have to retain any - front side issuers didn’t have to retain any risk.

And the BPs buyers could sell their position whenever they wanted to. So, now with the requirement that whoever holds the risk position has to retain it for 5 to 10 years, it’s going to be more permanent capital players that participate there. And it’s going to require higher yields and the buyers will have even more sale over the collateral.

So, our ability to dictate what risk we are willing to accept and what loans get funded in the deal et cetera. And then in addition to that, the [indiscernible] is also causing greater scrutiny in the space.

So if issuers want to do vertical slides and keep 5% of each tranche then a lot of the bottom tranche will be available and it won’t have to be held for a long period of time. So we will see, but it is exciting. And I think it fits us perfectly..

And the risk retention rules are already changed. So we should see this occurring -.

Well, it actually goes into effect in December of this year. So people are just preparing for it and modeling out what the best structure is and how much loan rates would potentially have to go up to borrowers to make it economic..

Got it, okay. Thank you..

[Operator Instructions] And our next question is from Mark DeVries of Barclays. You may now ask your question.

Thanks. Sorry if I missed this. Could you help me understand in comment that commercial credit was accretive to book value during this quarter. It seems little surprising just given the weakness we saw in spreads on commercial loans..

You could disaggregate, I mean if you look at it as a spread, yes. That was part of the reason book value declined. When you break down and say, okay, we have lost book value from our derivatives hedges on absolute basis and then compare how much we gain from commercial prices up during the quarter. Because basically rate sell are unbalanced.

Our CMBS went up in price. They just didn't go up in prices as much as they should have given the rate much. That makes sense..

Yes. That does it from me, thanks..

Thank you. And our next question is from Trevor Cranston of GMP Securities. Sir your line is now open. .

Hi thanks. Just a couple of detail follow-ups.

First, can you give us the notional balance of the swap book after the changes you made in the first quarter and then also just the weighted average term of the remaining swaps?.

I don't have that right in front of me, but I can - the average maturity is of about 4 years, the swap book and - I'm sorry what was the other question - the notional size. The notional size is approximately $6.9 billion. So the Q will come out later today..

Okay, got it. And then I may have missed this one John was kind of going through the returns on the various asset buckets. But can you talk about where you seen loan rates in those mezz loan market and kind of how those moved around with changes in CMBS spreads. Thanks..

On the loan market we are actually seeing – we saw somewhat better opportunities from the volatility and the market kind of reduce the ability for borrowers to borrow in the CMBS market. And so I'd say just generally not necessarily higher rates, but kind of similar range or better risk in our [indiscernible] LIBOR plus 7 to 10..

Okay, that's helpful. Thank you. .

Thank you. And our next question is from [Max Meyer] [ph] of Wells Fargo. Sir you may now ask your question. .

Hi good morning this is Max in for Joel. Just had a question with regard to the agency portfolio. We’ve know some your peers have taken out their extended agency to leverage a little bit and duration is a bit somewhat counteracts spread widening and other areas of the portfolio.

Can you just talk about how you see agency leverage moving forward and duration as a whole?.

Yes, I mean we're pretty focused on keeping our duration profile, our peer duration profile as close to zero as we can. So, I mean that's really what has driven a lot of our positioning within agencies.

So I mean that's why we've been - if you look at our agency portfolio over the last even couple of years, we had a pretty large migration from 30s into 50s and high risk and even within the 30 book, we just let it season its mostly higher coupons that are now shorter duration also.

So I mean that's kind of how we're thinking about agencies at this point because really we think there's a lot more probably more risk to spread volatility and its harder to control versus we have a very good - I think we have a very good ability to control our credit risk. So that's kind of how we’re thinking about.

So I don't see they will really change our agency allocation, I mean you're important obviously to have provide liquidity and all those sayings to me hopeful task but certainly within that book we want to try to drive out as much as interest rate risk as we can..

Okay, that's helpful. And then just one other question with regard to taking on the hedges swaps and also specific to the commercial portfolio, I know told your case series decision and then also some of your legacy CMBS.

Can you just give us an idea of the timing of those events within the quarter?.

It was throughout the quarter. Yes not necessarily all at once, but I'd say generally earlier in the quarter when we took off most of the swaps and sold most of the assets. And basically driven by the share repurchases that occurred really in the fourth quarter and into the first quarter we were still repositioning portfolio..

Great.

And keep in mind that the bonds we sold tended to be one is that you held for a long time that it really rolled down the curve it were, it didn't have, we didn't feel like I had a lot of I'd left so they tended to be shorter duration weren't as impacted by some of the loss so is a very much shorter cash flows there are ever kind of bonds that we felt like were in kind of helping us so much and could redeploy into buying back shares like we’d said or funding some of the commercial stuff - commercial real estate launch..

Okay, that's helpful. And just one last question if I may.

Do you think that level of swaps or hedges more broadly in that higher level of agency leverage around ten times is more normal for the future or do you think we can expect those things to revert in coming quarters?.

I think it's probably fairly normal. I mean I’d say the type of agencies we own and I don't think you can emphasize enough that if you have nine times leverage let's say on 30 years 3s is much, much riskier than the nine times on hybrid and 15s and up in coupon type assets that just don't have a lot of price volatility.

So yes, I would say maybe not 10 but probably nine times..

Okay, that's helpful. Thank you very much. And thanks for taking my question..

Thank you. And we have Brock Vandervliet again from Nomura Securities. Sir your line is now open. Mr.

Vandervliet your line is now open, kindly check if you are on mute?.

I’m sorry.

Just as a follow-up to the last question I guess given the movements you made this quarter and going forward should we expect essentially a rebuild in part of the swap position and therefore a higher cost of funds or is this essentially sustainable here?.

No, I mean I think where we are given our level of assets this is - we're hedged appropriately here..

Okay. So unless you decide to take up the book this is a reasonable level right here..

Yes. And I don’t anticipate as putting on long duration assets..

Got it. Okay, thanks..

Thank you. And at this time we don't have any question on queue. I would now like to hand the call over back to our speakers..

Okay, thanks. I appreciate everybody dialing in today, and we'll talk to you next time. Thanks..

Thank you. And that concludes today's conference. Thank you for participating. You may now disconnect..