Invesco Mortgage Capital Inc.
Q1 2020 Earnings Call Transcript

Published: 23 Jun 2020

[Operator:]

Welcome to the Invesco Mortgage Capital Inc. first quarter 2020 investors conference call. All participants will be in a listen-only mode until the question and answer session. At that time, to ask a question, 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 Brandon Burke with Investor Relations. Mr. Burke, you may begin the call.

[Brandon Burke:]

Thank you, and welcome to Invesco Mortgage Capital’s first 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.

[John Anzalone:]

Good morning and welcome to Invesco Mortgage Capital’s first quarter earnings call. I will give some brief comments before turning the call over to our President and Head of Commercial Credit, Kevin Collins, who will provide greater detail on our current portfolio, and our Chief Investment Officer, Brian Norris, who will expand on our go-forward strategy. Before getting started, I’d like to acknowledge the entire team at Invesco who have put in countless hours managing through this crisis and doing it with the added difficulty of working remotely. There is no way that we would be in the position we are in today without their efforts, so thank you to the entire team. I’d also like to acknowledge the support of both our Board of Directors and the senior management at Invesco who have provided all of the resources necessary to get through this crisis. Towards the end of the first quarter, the onset of the COVID-19 pandemic and the economic shutdown left in its wake caused unprecedented volatility and dislocation throughout the financial markets. Even with rates rallying significantly, prepaid protected specified pool agency mortgage-backed securities significantly underperformed as agency paper was being sold for cash settle at levels below TBA prices. The structured securities and credit markets were hit particularly hard as liquidity was severely impacted and valuations became distressed.

[Kevin Collins:]

Thanks John, and thanks to everyone on the line for your interest in Invesco Mortgage Capital. As John noted, our portfolio is now largely comprised of mortgage-backed credit investments, so that’s about 92% comprised of commercial mortgage credit and about 7% that’s comprised of residential credit. The COVID-19 pandemic and related decline in economic activity has made it pretty difficult for many borrowers to meet their financial obligations, so not surprisingly lodging and retail property markets have been impacted the most just due to travel restrictions, as well as the slowdown in retail activity.

[Brian Norris:]

Thanks Kevin, and good morning to everyone listening to the call. As John mentioned, the latter half of the first quarter and extending well into the second quarter proved to be a tremendously challenging environment for the company. Our team worked extremely hard towards the goal of reducing the company’s reliance on short-term mark-to-market financing for our credit assets as well as overall company leverage. To that end, by early May we successfully reduced our reliance on credit repo to zero with current overall company leverage below 0.8 times debt to equity.

[Operator:]

Our first question will come from Eric Hagen from KBW. Your line is now open.

[Eric Hagen:]

Thanks, good morning guys. Hope you’re doing well. On the asset sales to wind down the FHLB line, which assets do you think you might sell in order to accomplish that? Would they come from more of the triple-A, double-A category, or something in the positions that are lower rated than that? Then on the CMBS portfolio, the stuff that’s remaining, what’s the level of unrealized losses that are sitting in that portfolio, and what’s the unlevered yield in the CMBS portfolio now?

[John Anzalone:]

I’ll start with the home loan. The bonds underlying the home loan advances are double-A and triple-A predominantly, so those are the ones that would be sold to pay down that line. Again, as we anticipate the top of the capital structure improving as the TALF starts to get underway, we expect that to be relatively soon. I’ll let Kevin answer the second part.

[Kevin Collins:]

Yes Eric, to give you a sense for where we’re seeing things trade today and putting into context to what we currently own in our portfolio, I guess I’d start at the top of the capital structure for us, which is, I believe, about 30% of our portfolio that’s currently in triple-A CMBS. Those are--excuse me, 38% of our CMBS portfolio is triple-A. Those are largely junior triple-A rated positions, so in terms of where they’re trading, again it’s very dependent on transactions, but I’d call it around 160 basis points, double-A rated paper, anywhere from 250 to as wide as 400 basis points, and single-A paper around 450 basis points on a spreaded level, and triple-B looks more like 800 to anywhere 1,300 over in terms of current yields.

[Eric Hagen:]

Great, that’s helpful color. Maybe I can press you on the unrealized losses that are sitting in the portfolio today. We can see where it was at the end of the quarter, but based on the sales that have taken place since then, just what the market is on the overall portfolio and how much of that is in unrealized loss position. I’ll just ask my second question today. Just how much leverage do you think you might run in the agency RMBS portfolio as you transition back to that strategy?

[Kevin Collins:]

Yes, so I don’t have those specific numbers in front of me, Eric, but what I can tell you is, to kind of go back to what I walked you through, if you think through the junior triple-A rated positions, what is largely junior triple-As, as I mentioned, about 9% are , so those would be more senior positions. But at 5/31, those were around 250 basis points on a spread level. That looks more like 160 today. For the double-A positions at 5/31, that was 400 basis points, it looks more like 250. For single-A rated, 650 at 5/31, looks more like 450 today, and 5/31 for triple B, 1,300, looks more like 800, so that should provide some context in terms of what we see in the way of improvement. Just continue to see slowly increasing demand in the CMBS sector since TALF has come online - that’s certainly helped, and -- as the economy begins to slowly restart here, we’ve seen some new entrants into the space or crossover investors, so I think that’s helped as well.

[Brian Norris:]

Eric, I’ll take the leverage question. We anticipate--you know, the transition from our current portfolio to a predominantly agency only portfolio will likely take one or two quarters, so it’s going to take us a while to build up to this number, but it’s likely to be in the seven to eight times debt to equity on agency investments.

[Eric Hagen:]

Got it. All right, thank you very much.

[Operator:]

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

[Doug Harter:]

Thanks. Can you just talk about how you’re thinking of the capital structure - you know, preferreds are a very big part of your total equity base, and your thoughts around that?

[John Anzalone:]

Yes, thanks Doug. We are looking at opportunities obviously to raise capital that makes sense for shareholders, and over time we are looking to get the preferred to common ratio back in line, so I think post this call, post the filing of our Q, we’re going to start evaluating the best path forward in terms of capital structure. But yes, we realize that the preferred to common ratio is clearly not where it was, and we would prefer to get it back to more in line with historical averages.

[Doug Harter:]

Okay. Is there anything around the REIT rules and hold pool tests that would cause you to need to accelerate the transition back to agency, or do you have flexibility around that?

[John Anzalone:]

There’s some flexibility around timing, so we have a number of quarters to get back into hold pool compliance. But given the leverage on agencies, it wouldn’t take that long to get back up to 55% hold pools, so we do anticipate getting there relatively quickly.

[Doug Harter:]

Great, thank you.

[Operator:]

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

[Trevor Cranston:]

Great, thank you. A follow-up question on the FHLB financing which remains in place. Can you say if when you choose to pay that off, are there any frictional costs associated with that in terms of make-whole payments or termination fees?

[John Anzalone:]

No, no. We are free to prepay those as we sell assets, so there’s no penalties or anything like that.

[Trevor Cranston:]

Okay, got you. A follow-up on the question about unrealized losses. It sounded like you were suggesting that spreads have tightened pretty meaningfully in June. Is there any chance you can sort of estimate what that means in terms of your book value estimate, relative to where it was at May 31?

[John Anzalone:]

Yes, book value since 5/31 is up, I would say modestly. We have seen some valuation increases. It’s up a bit.

[Trevor Cranston:]

Okay. Then it sounded like there were some extraordinary costs that might have been in the G&A line in the first quarter relative to everything that happened in March. Can you say where you expect the G&A level to run going forward?

[John Anzalone:]

Yes Dave, do you have an estimate on that?

[David Lyle:]

Yes Trevor, we don’t expect it to change dramatically. We do--there are some additional costs incurred in association with navigating the COVID-19 crisis that we’ll see come through in Q1 and Q2, but beyond that we don’t expect really a dramatic change in G&A from historical levels within a reasonable band.

[Lee Phegley:]

With the exception of the management fees - this is Lee Phegley. The management fee will be coming down since it’s based on the NAV of the portfolio. Dave’s correct - there were some costs associated with the advisory work that you’ll see this quarter and in the second quarter, but those were not material numbers. But you will see the management fee come down.

[Trevor Cranston:]

Okay, got it. Then just to clarify, when you mentioned the low double-digit ROEs on the agency strategy, was that a gross ROE estimate or is that net of expenses and everything?

[Brian Norris:]

That was gross.

[Trevor Cranston:]

Okay, appreciate it. Thank you.

[Operator:]

Our next question will come from Jason Stewart with Jones Trading. Your line is now open.

[Jason Stewart:]

Hey, good morning. All my questions have been answered. Thanks a lot.

[Operator:]

I’m currently showing that was our last question for today. I’d like to now turn it back over.

[John Anzalone:]

Okay, well again, I’d like to thank everybody for your interest in Invesco Mortgage Capital, and we look forward to talking to you next quarter. Thank you.

[Operator:]

This concludes today’s conference. All participants may disconnect at this time. Thank you for your participation on today’s call.