Invesco Mortgage Capital Inc. (IVR) Earnings Call Transcript & Summary

Welcome to the Invesco Mortgage Capital Third Quarter 2026 Earnings Call. [Operator Instructions] As a reminder, this call is being recorded. Now I would like to turn the call over to Greg Seals in Investor Relations. Mr. Seals, you may begin the call.

Thanks, operator, and to all of you joining us on Invesco Mortgage Capital's Third Quarter 2026 Earnings Call. In addition to today's press release, we have provided a presentation that covers the topics we plan to address today. The press release and presentation are available on our website, invescomortgagecapital.com. This information can be found by going to the Investor Relations section of the website. Our presentation today will include forward-looking statements and certain non-GAAP financial measures. Please review the disclosures on Slide 2 of the presentation regarding these statements and measures as well as the appendix for the appropriate reconciliations to GAAP. Finally, Invesco Mortgage Capital is not responsible for and does not edit or guarantee the accuracy of our earnings teleconference transcripts provided by third parties. The only authorized webcasts are located on our website. Again, welcome, and thank you for joining us today. I'll now turn the call over to IVR's CEO, Kevin Collins, for his comments.

Good morning, and welcome to Invesco Mortgage Capital's Third Quarter Earnings Call. I'll provide a few comments before turning the call over to Brian Norris, our CIO. He'll discuss our portfolio in more detail. Also joining us on the call this morning for Q&A is our President, David Lyle; and our CFO, Mark Gregson. Now turning to the market. During the third quarter, we operated in a very challenging environment. Economic growth remained resilient, but financial conditions tightened as investors priced in additional Fed rate hikes. Treasury yields repriced sharply higher across the curve, driven largely by expectations for tighter monetary policy, but also stronger growth and concerns around fiscal deficits and increased Treasury supply. So look, to put the magnitude of the rates move in perspective, this represented one of the most significant increases in Treasury yields since the aggressive Fed tightening cycle of 2022. We saw 2-year yields rise more than 70 bps, 10-year yields rise more than 80 bps all during the quarter. Interest rate volatility also increased meaningfully during the quarter, especially in September. The MOVE index ended the quarter at 110, up from 83 at the end of the second quarter. And moving to the Fed, the FOMC's 25 basis point rate increase at the September meeting demonstrated its commitment to price stability, and it helped keep longer-term inflation expectations fairly well anchored despite elevated energy prices. 2-year breakevens increased to 2.5% at quarter end from 2% at the end of the second quarter, and 5-year breakevens increased more modestly to 2.4% from 2.3%. So collectively, these developments they -- look, they weighed on investor demand and they contributed to materially wider Agency RMBS spreads, and I'd say that's fair to state across the coupon stack. And I would call Agency CMBS spreads modestly wider. So against this backdrop, we generated an economic return of negative 11.6%. So that consisted of monthly dividends at $0.12 per share and a 16.1% decline in book value per share. Quarter-to-date, our book value is up roughly 4% and together with our accrued dividend, has generated an economic return of, call it, roughly 6%. At quarter end, our $8 billion investment portfolio consisted of $6.6 billion Agency RMBS specified pools, $0.7 billion Agency TBA and $0.7 billion Agency CMBS. Do want to note that in September, we tactically reduced our Agency CMBS allocation to what was 8.5% -- excuse me, to 8.5% from 11%, and we redeployed proceeds into Agency RMBS as spread widening made it relatively more attractive. And regarding our leverage, our economic debt-to-equity ratio increased to 8.3 turns from 7.5 turns, and we maintained a sizable balance of unrestricted cash and unencumbered investments exceeding $400 million. Now our EAD, it declined from $0.50 in the second quarter to $0.47 in the third quarter. So that largely reflected the impact of repositioning our swap portfolio. So as of quarter end, we hedged 99% of our borrowing costs with interest rate swaps and U.S. Treasury futures. Now regarding capital activities, we raised approximately $51 million through the ATM program during the quarter, with the goal of increasing our scale, reducing expenses per share and improving the liquidity profile of our common stock. Entering the fourth quarter, our outlook for Agency RMBS and Agency CMBS is constructive. Look, despite continued uncertainty surrounding inflation, monetary policy, geopolitics, recent spread widening has certainly enhanced projected returns and the relative value of our target assets. And I also want to note that we believe the liquidity and government guarantee of Agency MBS enhances its appeal, as investors are increasingly focused on managing risks. Further, Agency RMBS, we believe, is positioned to benefit from increased demand from the GSEs, from banks and from money managers. Lower interest rate volatility and de-escalation of tensions in the Middle East could also provide additional support. So against this backdrop, we're really focused on maintaining prudent leverage, ample liquidity and portfolio diversification, and we believe we're well positioned to navigate uncertainty and create long-term shareholder value. So now I'll turn the call over to Brian. He's going to go through our portfolio and our performance for the quarter in greater detail.

Thanks, Kevin, and good morning to everyone listening to the call. I'll begin on Slide 5, which provides detail on interest rates over the past year. As Kevin noted in his opening remarks, Treasury yields rose sharply in the third quarter, as 10-year and 30-year yields rose 81 and 68 basis points, respectively, to end at their highest levels in nearly 25 years. The yield curve steepened modestly in the front end, as 5- and 10-year yields rose more than 2-year yields, while the long end flattened given modest support at the 30-year point of the curve. Resilient economic growth, above-market inflation and persistent instability in the Middle East were the primary drivers of higher interest rates on the quarter. As a result, expectations for tighter monetary policy intensified, and the FOMC followed through with the 25 basis point increase in the Fed funds rate at their September 16 meeting. The increase was the committee's first since July 2023. And following the meeting, the market priced in nearly 4 more 25 basis point increases through the end of 2027, leading to a sharp increase in interest rate volatility in the latter half of the month. Positively, funding markets for our target assets remained stable throughout the quarter and over quarter end as lending capacity remained ample and financing spreads over SOFR were largely unchanged in the low teens. Slide 6 provides additional detail on Agency mortgage markets over the past year, with the third quarter highlighted in gray. During the quarter, Agency RMBS materially underperformed Treasuries, driven primarily by the sharp increase in interest rate volatility in September. That volatility weighed on investor sentiment and triggered deleveraging from hedge funds, along with a modest amount of convexity-related selling from servicers. While organic net supply remained manageable, incremental supply from banks and overseas investors added further pressure to the supply and demand backdrop. Positively, demand from the GSEs, money managers and mortgage REITs provided some support to valuations, but not enough to offset the broader supply-driven pressure. Agency CMBS spreads were largely unchanged for most of the quarter, however, serving as a powerful diversifier to Agency RMBS, given its limited exposure to interest rate volatility. The sector did not face the same selling pressure as Agency RMBS, only widening modestly the last week of September, as investors looked to monetize its outperformance relative to Agency RMBS. The dollar roll market for higher coupon Agency TBAs continued to benefit from favorable technical conditions, with implied financing rates from production coupons remaining below 1-month SOFR for much of the quarter, enhancing levered return potential in those coupons. Higher mortgage rates, however, weighed on specified pool payups and higher coupons, as refinancing activity remained subdued and demand for prepayment protection softened accordingly. Despite near-term pressure, we continue to view carefully selected specified pools as an effective tool for managing convexity risk in Agency mortgage portfolios. With the mortgage universe largely extended and trading at a discount to par, convexity risk is more one-sided at current rate levels, and we believe this provides an attractive entry point for adding prepayment protection. Slide 7 summarizes the changes in our portfolio over the course of a relatively active third quarter. While higher interest rates and wider spreads offset net purchase activity to drive a decline in our total portfolio market value of 2.3% quarter-over-quarter, our highly liquid portfolio and focus on active management provided numerous opportunities to tactically adjust allocations to improve the investment profile of the company. Early in the quarter, we invested monthly cash flows and proceeds from our ATM issuances into specified pools, given their improved relative value versus Agency TBA. Most of these purchases occurred in 30-year 5.5% and 6% coupons, as the higher rate environment reduced prepayment risk in higher coupons, leading to a slight decline in our 4.5% and 5% coupon allocations. In addition, we swapped a portion of our Agency TBA allocation into specified pools, further improving the convexity profile of our portfolio by reducing our sensitivity to interest rate volatility. We sold our remaining Agency IO positions, which were a strong performer in the portfolio over the last few years. When purchased, they offered attractive unlevered yields in the high single digits to low double digits. Recent demand for these low coupon IOs has been robust, given the very slow and predictable prepayment behavior over the past few years. And market yields have declined to the 6% to 7% range, reducing their attractiveness as an unlevered holding for IVR. We reinvested proceeds from these sales into 30-year 6.5% Agency TBA, which benefits from a highly attractive dollar roll market, providing an ROE well over 20%. Lastly, we rotated a portion of our Agency CMBS allocations into lower coupon, 2.5% and 3% specified pools, seeking to benefit from the resilience in Agency CMBS valuations by reallocating into a similar risk profile but more attractively priced deep discount Agency RMBS. As a result of this portfolio activity, our allocation to specified pools increased from 73% of our total investment portfolio to 83% during the quarter, notably improving the convexity profile at attractive entry points. Levered gross returns on production coupon specified pools hedged with swaps were in the high teens to 20% ROE, with the current coupon spread to the 5- and 10-year SOFR blend ending the quarter near 160 basis points, its widest level since March. Given the growth in specified pools within the portfolio, our allocation to Agency TBA and Agency CMBS declined from 14.7% to 8.3% in Agency TBA, and 11.1% to 8.3% (sic) [ 8.5% ] in Agency CMBS. Both remain core holdings in our portfolio despite the decline in allocations, with Agency TBA continuing to provide attractive levered gross returns in the high teens to low 20s ROEs as implied financing rates persist near or below 1-month repo rates in production coupons. Agency CMBS spreads widened modestly at the very end of the quarter, but the sector notably outperformed Agency RMBS across the coupon stack, providing beneficial diversification to the total investment portfolio. Financing capacity has been robust as we continue to fund our positions with multiple counterparties at attractive levels. Despite the modest decline in our allocation, we continue to believe Agency CMBS offers many benefits, mainly through its inherent prepayment protection and fixed maturities, which reduce our sensitivity to interest rate volatility. We will continue to monitor the sector for tactical opportunities to adjust our allocations to the extent the relative value between Agency CMBS and lower coupon Agency RMBS shifts, recognizing the overall benefit as the sector diversifies risks associated with Agency RMBS. Slide 8 details our funding book at quarter end. Repurchase agreements collateralized by our Agency RMBS and Agency CMBS investments increased from $6.2 billion to $6.8 billion, largely reflecting our rotation from Agency TBA to specified pools, while the total notional of our hedges increased from $6.1 billion to $6.8 billion. Excluding the implied funding via our Agency TBA allocation, our hedge ratio remains elevated at 99%, given the increased uncertainty regarding the path of monetary policy. In addition, we continue to maintain significant liquidity with approximately $401 million of cash and unencumbered investments at quarter end, equating to 44% of our total equity. Slide 9 provides detail on our hedge book at quarter end. The composition of our hedges remained weighted towards interest rate swaps, with 76% of our hedges consisting of interest rate swaps on a notional basis and 67% on the dollar duration basis. Swap spreads widened during the quarter, serving as a modest tailwind for our performance. We remain comfortable focusing the majority of our hedges in interest rate swaps, as swap spreads are historically tight and offer an attractive hedge profile relative to Treasury futures. As shown in the table at the bottom of the slide, we adjusted the maturity profile of our hedge book during the quarter, reducing the notional amount of hedges with maturities less than 3 years from $1.9 billion to $1.2 billion, and rotating that exposure into longer maturities across the maturity structure. The extension of hedge maturities was a result of the sharp rise in interest rates, as we adjusted our hedges to account for the new interest rate environment, given the extension in our Agency RMBS portfolio. As Kevin noted, this had a negative impact on our EAD for the quarter, as the majority of our shorter hedges were added to the portfolio in a much lower interest rate environment and had lower coupon rates than current market swaps. Importantly, the lower EAD had no impact on our economic return given the substantial market value gains in those lower coupon swaps. Slide 10 provides our model-based estimates of book value sensitivity to instantaneous shocks in interest rates and mortgage spreads. Looking first at the table at the top of the slide, we modestly reduced our duration gap quarter-over-quarter, reflecting a more cautious stance on the direction of interest rates. On the bottom table, the increased sensitivity to changes in mortgage spreads reflects our higher leverage quarter-over-quarter. We believe the current environment is conducive to higher leverage, as valuations have been well supported at wider levels and our liquidity remains ample. Importantly, we did not execute any net sales during the quarter, maintaining our exposure to the more attractive valuations moving forward and allowing the company to capitalize on further normalization in valuations. To conclude our prepared remarks, the management team remains committed to delivering exceptional investment performance for our shareholders. While the volatility of the third quarter certainly presented a challenging backdrop, we were pleased with how well the market functioned throughout, allowing us to reposition the portfolio to capitalize on more attractive opportunities. Although persistent geopolitical risks and the uncertain path of near-term monetary policy may create some volatility in mortgage valuations, we continue to believe the medium- to long-term outlook for our target assets remains constructive, underpinned by attractive valuations and supportive supply and demand technicals. Additionally, our liquidity position remains ample, providing substantial cushion to withstand additional market stress while maintaining the flexibility to capitalize on opportunities in our target assets as the investment environment improves. Thank you for your continued support of Invesco Mortgage Capital. Now we will open the line for Q&A.

[Operator Instructions] Our first question comes from Marissa Lobo with UBS.

I just wanted to start with the dividend. At the current level, it's paying out roughly 20% of book value. Can you give us an update on how you're thinking about the appropriate dividend level from here?

Yes. Sure, Marissa. Thanks for your question, and thanks for joining the call today. I guess I'd start by saying that current ROEs, as was mentioned for our target assets, are 18% to 20%. So we're going to be discussing the dividend with the Board at our upcoming meeting, really with an emphasis around market conditions and available investment opportunities in relation to our current payout of book value.

Got it. And just looking at the portfolio, you noted TBA financing is attractive relative to repo. So how are you weighing that against the convexity benefits of specified pools when comparing returns?

Marissa, it's Brian. Yes, I mean, I think, like I said, Agency TBA ROEs are certainly attractive given where implied financing rates are. But that can also not be as durable as the benefits that we see in specified pools. And so I think at about 8%, we're very comfortable with our allocation to TBA at this level. But I noted convexity benefits of specified pools right now are a bit more one-sided. I think extension risk has largely played out in the market. Certainly, as of the end of September, we've seen a pretty decent rally in rates since then. So some of that has reversed. But we're still very comfortable owning the majority of our allocation in specified pools, just given the kind of the -- not only convexity benefits, but also fairly attractive ROEs and durability of those ROEs.

Our next question comes from Doug Harter with BTIG.

Looking at Slide 14 and Slide 13, can you just talk about how you're thinking about the risk positioning, both in leverage and cash unencumbered, and kind of what are levels that you're kind of willing to kind of comfortably hold to the extent that we have kind of other pockets of volatility and say, October's book value recovery were to reverse?

Doug, it's Brian. Yes, we're certainly comfortable with the current level of leverage and cash unencumbered. It's something that we obviously monitor on a daily basis and run against various risk models and metrics to determine the appropriate amount. And leverage has come down since the end of the quarter, just given the improvement in book value and mortgage spreads as well. So we're certainly comfortable. We did let it drift higher over the course of the quarter given that underperformance. And so we're comfortable at higher levels. But again, we think valuations are pretty attractive, and supply and demand technicals are very supportive as well. So that all kind of blends into kind of our view on where we're comfortable with leverage.

Got it. And I guess, going the other way, like how comfortable would you be to kind of pick up leverage to take advantage of the current opportunity? Or do you feel like you kind of have the right risk positioning on?

Yes. I think probably the latter. If we did see mortgage spreads kind of reverse from here, the recent tightening that we've seen and go wider and take our leverage a little bit higher, that's not something that we would be uncomfortable with, but it's not something that we're necessarily looking to do by adding assets at this point.

Our next question comes from Trevor Cranston with Citizens JMP.