Welcome to the Invesco Mortgage Capital Inc., Second Quarter 2020 Investors Conference Call. All participants will be in a listen-only mode until the question-and-answer session. At that time, please press star followed by the one on your phone. As a reminder, this call is being recorded.

Now, I would like to turn the call over to Jack Bateman, Investor Relations. Mr. Bateman, you may begin the call..

Thank you, and welcome to Invesco Mortgage Capital’s second quarter 2020 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..

Okay. Thank you. Good morning and welcome to Invesco Mortgage Capital's second quarter call. I will give some brief comments before turning the call over to our and our Chief Investment Officer, Brian Norris to discuss the current portfolio in more detail. The second quarter was an eventful one.

In the beginning of the quarter, the financial markets were still in the midst of an unprecedented liquidity event as the economic activity shut down to combat the COVID-19 pandemic. As we noted in our last update, this triggered dislocations across the structured security space that impacted our ability to meet margin calls.

In response to the crisis, we took a number of steps to increase our liquidity position, while reducing leverage. Over the course of the quarter, we sold $6.9 billion of investments and repaid $6.3 billion of repurchase agreements. We also reduced our secured loans by $610 million.

We elected to hold $1.6 billion of mostly non-agency CMBS and GSE credit risk transfer paper that would benefit as market conditions improves. On Slide 3 of the deck, you can see a breakdown of the composition and credit quality of these holdings as of 6/30.

Slide 4 provides more details about our response to the dislocations in the financial markets that we saw at the end of March. Our immediate goals were to reduce our exposure to mark-to-market financing and credit assets to increase liquidity and to retain credit assets that we felt were poised to benefit as markets recovered.

To that end, we were successful in eliminating our credit repo entirely..

Alright. Thanks, John, and good morning to everyone on the call. I'll begin on Slide 7, which detailed the progress we've made in July towards the strategic transition John discussed in his prepared remarks.

Given our success in building liquidity and reducing our reliance on short-term mark-to-market financing on our credit investments during the second quarter, we began the month of July with ample liquidity and repo capacity to begin implementing the transition towards an agency RMBS focused strategy.

Our agency RMBS purchases in July totaled $2.2 billion and 30-year low coupon specified pools as detailed on Slide 7. We were able to source attractively-priced new issue collateral stories, including loan balance, low FICO, high LTV and GEO pools, which consists exclusively borrowers in slower paying states, such as New York, Florida and Texas.

We also focused a significant portion of our purchases on lower pay-up stories, such as those originated and serviced exclusively by banks in order to mitigate our exposure to pay-up premiums.

That hedge our funding costs and interest rate exposure associated with these purchases, we executed $1.8 billion of interest rate swaps with maturities between 4 to 7 years. In addition to our purchases, we sold $547 million of credit assets in July, as the recovery in prices continued with strong demand during the month.

In particular, higher quality CMBS was the beneficiary of the June launch of the TALF program, as spreads tightened dramatically, and the AAA and AA rated assets refinanced at FHLB through our captive insurance subsidiary.

We sold $470 million of these assets and were able to pay down $435 million of advances from the FHLB during the month, resulting in a secured loan balance at the FHLB of $305 million as of July 31st..

Our first question will come from Doug Harter with Credit Suisse. Your line is now open..

Thanks.

Can you help us to think about what your spread income would be on the agency portfolio rotated into in July and how that would compare to the credit assets that you ?.

Yes, Doug. This is Brian. I can start answering that, and if the credit guys want to jump in. On agencies, our NIM is approximately 100 to 125 basis points. So on specified pools that equates to roughly 10% to maybe 12% hedged ROE. And the credit investments, the ones that we're holding unlevered have book yields that are well-below that.

But like we said, we expect continued price appreciation there. And so, that's certainly supporting our book value and adding value in that way..

Great.

And then, I guess just help us to think about within the agency side, given the appreciation in spec pools and the specialness of TBAs, kind of what part you're finding most attractive today and where that incremental capital might go?.

Yes, we've been finding most value in lower coupon. So, in 30 year, two, two and half and a little bit in threes as well, significant size in whole pool is more difficult in higher coupons. Like I said, spec pools, in those lower coupons are still providing kind of very low double digit ROEs.

On the TBA front, that's not something that we've invested in at this point. But it's certainly on the radar and we're looking to do that here in the near-term. And ROEs on TBAs are a little bit more attractive just given kind of the negative impact financing that you get off there, so those are more like mid-teens..

Our next question will come from Eric Hagen with Keefe, Bruyette, & Woods. Your line is now open..

Thanks and hope you guys are doing well. I'm curious what led to the decision not to raise capital back in June and early July since the market was more or less giving you that opportunity.

Secondarily, have there been any options you've explored the rebalance the capital structure, including things like tendering for your preferred stocks?.

Yes. Hi, Eric. It's John..

Hi, John..

Yes. Hi. We've looked at it. We're always looking at the capital structure and we're continuing to kind of evaluate our options for kind of getting the preferred common ratio kind of more to our historical levels. So, we are continuing to look at that.

In terms of raising capital in the quarter, by doing a capital raise, I mean, it was just, I mean, I think it was still a little bit difficult to kind of get that done given the cost of raising capital in with the markets still kind of in a bit of turmoil, but we absolutely are always looking at different ways to do that..

Okay. Got it. Thanks. Thanks for that. And then what's the plan surrounding the funding for the CMBS portfolio, once your line with the FHLB gets wound down by year-end? Do you have any securities that are currently being funded through TALF? And finally, what's the funding rate on your agency repo right now? Thanks.

Yes, Eric. It's Brian. Yes, I hope you're doing well as well. So, I guess I'll answer last to first here. Financing on agencies are pretty attractive. They're LIBOR plus 8 or 9 basis points. So, we're talking maybe 24 basis points all-in for one month repo. And then, we did not finance anything to TALF because that required new purchases.

I believe they had to be purchased within a month of kind of putting them into the TALF program. So, obviously all of our holdings have been purchased much earlier than that. And then lastly, we don't anticipate going back into short-term mark-to-market financing for our credit assets.

So, the intention is to continue to look for attractive dispositions in that space..

And our next question will come from Trevor Cranston from JMP Securities. Your line is now open..

When you guys talk about continuing to hold on to the CMBS book in order to capture continuing expected price appreciation, can you talk about kind of how much you think is left in a few sort of -- is your view that, spreads could get all the way back to pre-COVID levels? And maybe just provide some color on how long you're willing to hold on to the portfolio to capture the potential upside?.

Yes. This is Kevin. Thanks for your question. I guess I would say that, we do think that potential for additional tightening certainly exists. We've been encouraged by the fact that, investor demand is continuing to increase for credit risk. The U.S.

economy is obviously slowly reopened, and we've seen some improvement trends, although certainly challenges as well. We were encouraged to see that the top programs has been extended throughout the rest of the year, which we think give us -- certainly, at least a couple more a few more months, we think potential upside that exists.

I think the potential for additional appreciation is arguably best addressed by looking at where spreads are today relative to where they were pre-COVID. And if you think about that, the majority of our positions are AA rated, so again AA rated CMBS.

They're probably trading at or at least it was a 731 when they weren't marked around 350 basis points over swaps. And so, these same positions traded around 100 to 115 basis points pre-COVID. So, it's not -- to say that we think that we will see full recovery certainly not in the near term but we think no momentum is there.

In terms of single A-rated positions, those are probably marking where they're very wide ranging, I would say. 350 to 780 basis points at 731, maybe 550 basis points over swap level on average. But those positions again, traded around 160 basis points pre-COVID and BBB assets look something more like 900 basis points at 731.

And those bonds traded as high as 350 pre-COVID, so we definitely think that there is room, but we have experienced a fair amount of credit spread tightening over the last couple of months already.

And at one of the, I guess favorable backdrops here for us just a notable lack of supply as new issuance that slowed loan origination have declined notably..

Okay, got you. Thanks for that color. And then as you guys are redeploying into the agency market.

Can you talk about the leverage levels that you're sort of comfortable using on that trade right now?.

Yes, hi, Trevor, it's Brian. So, leverage is ranging in the 7 to 8 times. Overall, leverage right now is around two, but obviously as we continue to transition that will continue to decline up to that 7 times debt to equity range..

Okay, got it. And then just one more question on the capital structure, wondering if you could comment on specifically or something like a swap of common shared for preferred is sort of one of the angles you guys have looked at, and this is something that is feasible? Or if it -- or if you think it isn't for some reason? Thanks.

Yes, hi, Trevor. It's John. Yes, I mean, that is one of the things we were evaluating about whether it makes sense to do a swap like that. So, that's one of the things we've been looking at. We're trying to figure out what makes sense for shareholders in terms of depending on where we're trading in terms of common to book values and things like that.

So, as I think once we get past, the financials release from last night, we're going to reevaluate where we are and what makes sense for that..

Our next question will come from Jason Stewart with JonesTrading. Your line is open..

Hey, good morning. Just curious if you could give us some thoughts on why you avoided the TBA trade and agency just your thought process there..

Yes. Hi, Jason, it's Brian. I wouldn't say that we're avoiding the TBA trade. It's certainly something that we're interested in putting on here in the near-term, but we had some things that we wanted to get on the books first in July and that included hopeful specified pools.

So, we had to -- first thing was, we had to get back in line with the whole pool test..

Okay..

So, those are the pool where the first way to do that. And then, as we move forward, we anticipate that, TBA trade to remain pretty attractive over the near to medium-term, just given the fed support and kind of their medium-term outlook. So that's certainly something that we're going to be looking at here surely..

Okay. Understood. And then on the additional credit assets that don't rely on short-term mark-to-market financing where you can put capital to work.

Can you give us some color on what you're thinking there?.

Yes. So, we own roughly $500 million on an unlevered basis away from the FHLB and those are the bonds that we believe have the most significant upside potential. So, we're likely to hold onto those, as we realized that potential. Away from that, we're continuing to explore our options in the credit space.

It's certainly more extensive to finance on a non-recourse basis. So, the opportunities will be fewer there. But, it's certainly something that we're going to continue to explore..

We are currently showing no additional questions at this time..

Okay. Well, thank everyone for joining us and we look forward to talking to you again in November..

This concludes today's conference. Thank you at attending today's call. All participants can disconnect at this time..