Invesco Mortgage Capital Inc. Q3 FY2025 earnings call

Market Environment

• Strong momentum from mid-April continued, with financial markets rallying due to expected monetary policy easing, strong corporate earnings, and improved economic growth.
• Inflation measures were hotter than the Fed's 2% target, labor market data showed sluggish growth, and the FOMC cut rates twice in September.
• Interest rates declined across the treasury yield curve, with shorter maturities leading, and industry volatility declined.

Portfolio Performance

• Agency mortgages performed well with the decline in interest rate volatility and supportive environment for risk assets; higher coupons were dampened by prepayment risk but premiums on specified pool collateral improved. Agency CMBS risk premiums declined with increased investor demand.
• Book value per common share rose 4.5% to $8.41, and economic return was 8.7% for the quarter.

Capital Structure

• Leverage ticked up to 6.7x. Raised $36 million by issuing common stock through ATM program.

Sector Views

• Constructive on agency mortgages with balanced near-term risks and favorable longer-term outlook due to lower interest rate volatility, steeper yield curve, etc. Agency CMBS offers attractive risk-adjusted yields and diversification benefits. Anticipated bank regulatory capital rule changes would boost demand for both sectors.

The investment portfolio was $5.7 billion at quarter end, consisting of $4.8 billion agency mortgages (approximately 84.2% of the portfolio) and $0.9 billion agency CMBS (approximately 1.58% of the portfolio). Book value per common share increased 4.5% to $8.41 at quarter end. Combined with the $0.34 dividend, the quarter had a positive economic return of 8.7%. Leverage ticked up slightly to a debt-to-equity ratio of 6.7% from 6.5x.

Forward-Looking

• Further easing of monetary policy expected to lead to a steeper yield curve and lower interest rate volatility, supportive of agency mortgages long term.
• Near-term risks for agency mortgages balanced after recent outperformance; nominal spreads tightened 20 basis points during the quarter, valuations attractive.
• Agency CMBS retains benefits like prepayment protection and fixed maturities, with levered gross ROEs in low double digits, and will monitor relative value with agency RMBS.

Risks

• Repo spreads widened in late September due to steady T-bill issuance squeezing dealer balance sheets, and further adjustments may be needed before spreads unwind.
• Interest rate volatility, though declined, still poses some risk.
• Uncertainty around bank regulatory capital rule changes and their full impact on demand for agency mortgages and CMBS.

Q: Talk about net duration exposure and yield curve shape, and thoughts on using options given decline in cost of volatility.

A: On yield curve, started to reduce steepener preference as Fed cuts less certain, resulting in slightly flatter curve. Historically preferred empirical duration close to 0, but with more premium prices, has more risk to interest rate rally; model duration is slightly long. Still prefer interest rate swaps, expect swap spreads to normalize, and may move more to treasury futures. On options, will consider given decline in cost of volatility but will monitor relative value.

Q: Appetite for changing capital structure with preferred buybacks and common, and relative value between Agency CMBS and Agency RMBS.

A: Preferred buybacks were small, impact minimal. Currently seeing accretive investment opportunities, so not buying back common stock now; would consider if conditions change. Agency RMBS provides more attractive ROE currently, Agency CMBS return potential in line with lower coupon Agency RMBS, will look for more compression between them before significantly moving to Agency CMBS but continue to hold for convexity benefits.