Welcome to Invesco Mortgage Capital Second Quarter 2019 Investor Conference Call. All participants will be in a listen-only mode until the question-and-answer session. As a reminder, this call is being recorded. Now, I would turn the call over to Brandon Burke, Investor Relations. Mr. Burke, you may begin the call..

Thank you, and welcome to Invesco Mortgage Capital second quarter 2019 earnings call. The management team and I are delighted you’ve joined us, and we look forward to sharing with you our prepared remarks and conducting a question-and-answer session.

Joining today are John Anzalone, our Chief Executive Officer; Kevin Collins, our President; Lee Phegley, our Chief Financial Officer; Dave Lyle, our Chief Operating Officer; and Brian Norris, our Chief Investment Officer..

Good morning, and thank you for joining us on IVRs second quarter earnings call. This quarter commemorates the 10th year anniversary of IVRs Initial Public Offering. Investors in IVRs common stock have achieved an annualized total return of 11.4% since our inception on June 25, 2009.

I’d like to take this opportunity to thank everyone who supported us over the past decade. I’m pleased to announce core earnings for the second quarter of $0.46, despite an increase in financial market volatility, characterized by sharply lower rates, elevated prepayment fears and wider spreads in the agency mortgage market.

Our book value was stable ending the quarter at $16.21. Combined with our $0.45 dividend this produced an economic return for the quarter of 2.3%. This brings our year-to-date economic return to a robust 12%.

Before Brian goes into details of the portfolio, I want to take a few minutes to discuss how through active management, we produced results that have not only allowed us to recently increase our dividend, but to consistently out earn that dividend while keeping book value volatility mitigated.

There are three things that I believe has been critical to our success. The first is the recent repositioning of our assets. We purposely rotated into assets with greater prepayment protection and going forward we believe managing convexity risk is going to be the greatest challenge facing our space.

While we have always focused on buying specified pool collateral. Over the past several quarters, we’ve rotated out of areas of the agency market were prepayment protection is less readily available, namely 15 year and hybrid collateral and into prepay protected 30 year specified pools..

Thanks, John and good morning to everyone on the call. I’ll start on Slide 6, where I like to highlight the advantages of our actively managed hybrid strategy and providing book value stability. Our equity and asset allocations to agency in credit assets remained relatively stable.

We continue to rotate out of Agency RMBS and into Agency CMBS given its attractive prepayment characteristics and funding levels. Our Agency CMBS position grew 13% total assets during the second quarter, up from 9% in the first quarter with an offsetting decline in Agency RMBS assets.

This rotation within agency assets allowed us to keep leverage largely unchanged, while maintaining core earnings above our dividend.

The increase in Agency CMBS over the past year, accompanied by the rotation out of less prepay protected 15-year and hybrid agency RMBS collateral and into 30 year specified pools, increased our total allocation to assets with prepay protection to 86% of the total portfolio, up from 62% in the second quarter of 2018, which should provide additional book value protection and a more predictable core earnings stream despite the recent sharp move lower in rates.

In addition to the portfolio rotation within our agency assets, they continued strong performance in seasoning of our credit assets also supports book value stability, as embedded property price appreciation, improves credit quality and shortening duration dampens spread volatility.

Lastly, we were also active in managing our hedge book during the quarter making adjustments across the swap curve to lock in lower fixed rates while also responding to movements in the durations of our assets as interest rates rallied.

Moving on to Slide 7, the pie chart in the upper left hand corner of the slide displays the composition of our Agency RMBS assets.

Our total Agency RMBS book declined by approximately $640 million during the quarter, through a combination of pay-downs and sales as capital was deployed into Agency CMBS, but the composition within our Agency RMBS book remained relatively unchanged.

Generic Agency RMBS spreads widen during the quarter, and particularly in May as sharply lower interest rates and higher volatility weighed on valuations. Underperformance in this sector was largely offset by our allocation to prepayment protected specified pools as payoffs on our holdings appreciated by approximately two thirds of a point.

To start pool pay-ups have risen sharply since the beginning of the year and we expect them to be well supported at these levels, as lower interest rates and a worsening environment for TBA increased demand for prepay protected assets..

We will now begin the question-and-answer session. Our first question comes from Doug Harter with Credit Suisse. You may ask your question..

Thanks. Obviously, as you guys mentioned prepays or spec pools have done well in pay-ups are now relatively high.

Just wondering how you see kind of the trade-off today between kind of those high pay-ups and kind of higher pre-pays in more generic collateral?.

Yeah. Thanks, Doug, this is Brian. Yeah, we’ve certainly seen an increase in pay-ups and like I said, I think given the current environment, we expect those pay-ups to persist at these levels.

The benefit of specified pools is certainly kind of the, the lack of negative convexity that you see in them, so you see much steadier duration profile on the bonds and longer duration..

And then I guess, if you could just talk about, I guess, how you’re thinking about protecting book value -- just from those spec pool pay-ups, if we were to kind of get a surprise increase in rates similar to kind of say the experience of the taper tantrum in 2013 and kind of what lessons might have been learned from there, if we were to see kind of spec pool prices come down sharply?.

Right. A couple of things there. We do focus on lower pay-up to the extent that we can. Lower pay-up story. So we’re talking kind of low FICO, high LTV, high loan balance bond. So we’re avoiding the extremely high pay-ups that we’re seeing in the market right now.

And then secondarily, just the reduction overall in our portfolio to Agency RMBS kind of insulates the entire portfolio, we’ve seen our percentage of total assets to the Agency RMBS sector shrink from about 70% to 60% over the last year. So we think that’s going to, to help insulate us from any changes in pay-ups..

Thank you. And next question comes from Eric Hagen with KBW. You may ask your question..

Thanks. Good morning guys. I’ll kind of tag along to some of the questions Doug was just asking and maybe go into the CMBS sector too.

So as you guys think about the relative value between deploying new capital into Agency RMBS versus CMBS, how you guys are thinking about that because it seems like the more favorable prepaid profile that you guys talked about for CMBS would imply much stronger relative value considering the environment we’re in.

I’m just trying to understand how you think about that? And I guess, what I’m really trying to ask is, what prevents you from being much more aggressive in rotating out of RMBS and into CMBS?.

Yeah. Thanks, Eric. I’ll take this one again. Yeah, certainly, you’re on the right path there. I’ve been reinvesting most of our pay-downs into Agency CMBS, we continue to like that story. There’s less supply there. So that makes it a little more difficult to be too aggressive.

We can’t necessarily rotate large percentage of our portfolio just given that we would likely tighten the market on it. So as long as the ROE’s are relatively close to each other between Agency CMBS and RMBS. We will definitely lean toward the Agency CMBS side, but again just given more limited supply there.

It does dampen our ability to transition significantly..

Got it, that certainly makes sense. Can you just give us a snapshot of where levered ROE’s on Agency RMBS and CMBS stand today relative to earlier in the year. Call it mid-February-ish when you guys raised capital? Thanks..

Yeah, mid-February we were talking probably mid-teens, say 14% to 16% ROE’s and now we’re low double digits. So, like I said earlier on specified pools we’re seeing NIMs and 75 to 100 basis points range. So that would imply low double digits into maybe 13% area..

Okay.

And quarter-to-date, how has one-month’s repo changed? Where are you guys roll-in three-month repo on the agency side?.

Yeah. On agencies, it’s come in quite a bit, mainly due to LIBOR. And like I said, spreads have widened a little bit financing spreads that is, but we are seeing pretty significant pickup in or I’m sorry more attractive financing levels given the pressure on LIBOR..

Have rates dropped to the full 25, at the Fed cut? Or has it been something less than that?.

Yeah, we’re getting pretty close. I want to say, we’re around $2.30, low $2.30’s on agency repo right now.

So we were certainly in the $2.50, $2.60 area not too long ago?.

Got it. That’s helpful color. And then on the non-agency RMBS. How should we think about pre-pays there, just call it over the near term and what that does to the overall kind of return in the strategy, just given that you hold those bonds at a discount? Thanks..

Yeah. Hey, this is Dave Lyle. I’ll take that one. We had seen them tick up a bit as rates have rallied and that shouldn’t be a surprise, there is still some rate incentive in that collateral despite the seasoning, although I will say, we saw when rates were very low in that, in those same pools in 2016.

We saw a greater increase in pre-pays and given that those borrowers had seen, have seen low rate levels before it may not be as sensitive this time around, but at the same time, we have additional home price appreciation. So there could be better borrower equity position that will make up for some of that.

So I would, short answer is I would not expect pre-pays to run as high as they did in 2016, but at the same time, we have and will continue to see them run a little bit higher, which is positive for yields on that part of the book given that book values that are at a discount are in these bonds..

Thank you. . Our next question comes from Trevor Cranston with JMP Securities. You may ask your question..

Hey, thanks. Follow up on Eric’s last question about pre-pays, and I guess resi credit book. More specifically on the CRT portfolio.

I was just wondering if you guys could talk about what kind of premium your CRT portfolio currently trades at, and what impact do you think you could see on that book from faster pre-pay speeds?.

Yeah, sure. That’s a good point. I should clarify my, my last answer related to the legacy book, so it is distinctly different story for CRT. I don’t want to quote our exact premium on our season CRT, but generally 2014, 2016 type M2s and M3s have a premium anywhere from call it 6 to 12 points over par and there is some prepayment sensitivity there.

So the fact that the weighted average lives will shorten as collateral speeds increase means that you have to amortize that premium over a shorter period of time and that’s not helpful for spreads.

So we have seen some drag on our season CRT book just in terms of spread widening and valuation performance and we highlighted that in our presentation and prepared comments is one of the areas of our book where we did suffer a little bit of valuation decline. But overall, we continue to like those bonds.

We had a very good entry point given that, we built that book several, several years ago. And it’s kind of a portfolio that can be recreated today at the spread levels that we put it on, despite the widening of spreads that we’ve seen.

So the ROEs being generated by that will continue to be accretive and beneficial for the portfolio despite some of the spread widening caused by faster fee base..

Got it, okay. And then on the hedge portfolio, you guys talked about a bit about the benefits of dynamically hedging as rates have come down a lot. Looking at Slide 13. It doesn’t look like there is any big changes in the notional swap position anyways.

Can you talk a little bit in more detail about what the changes to the hedge book were and maybe also comment on kind of where you’re running the duration gap currently?.

Sure. Yeah, this is Brian. Yeah, most of the changes. So we did extend out our maturities a little bit. So and we also were able to take-off some swaps and our treasury futures.

Just as kind of the durations on our Agency RMBS assets we’re shortening, we were able to take some swaps off and also like I said, kind of lock-in those lower rates in longer duration, so extended that out a little bit. So it was a little bit of, we don’t have our treasury future exposure kind of on there, but we did take some of those off as well..

Yeah, I’d like to add that our current positioning in terms of, equity duration. We have -- empirically we’re running pretty close to zero duration right now. I mean, give or take, a year or two given how volatile, the rate environment is, but it’s been remarkably stable..

Okay, great. That’s helpful. Thank you..

Thank you. At this time, I’m showing no further questions. I’ll turn the call over to John Anzalone..

Okay. Well, I’d like to thank everyone for joining us on the call this morning. And I’d also like to thank everyone who has helped make IVR successful over the past decade, and we look forward to joining you on next quarter. Thanks..

And this does conclude today’s call. We thank you for your participation. At this time you may disconnect your lines..