Participants

Greg Seals; IR Contact Officer; Invesco Mortgage Capital Inc

John Anzalone; Chief Executive Officer; Invesco Mortgage Capital Inc

Brian Norris; Chief Investment Officer; Invesco Mortgage Capital Inc

Doug Harter; Analyst; UBS Securities LLC

Trevor Cranston; Analyst; Citizens JMP Securities, LLC

Jason Stewart; Analyst; Janney Montgomery Scott LLC

Presentation

Operator

Welcome to the Invesco Mortgage Capital fourth-quarter 2024 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.

Greg Seals

Thanks, operator, and to all of you joining us on Invesco Mortgage Capital's quarterly 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 at 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 webcast are located on our website.
Again, welcome. Thank you for joining us today. I'll now turn the call over to IVR's CEO, John Anzalone.

John Anzalone

Good morning, and welcome to Invesco Mortgage Capital's fourth-quarter earnings call. I'll provide some brief comments before turning the call over to our Chief Investment Officer, Brian Norris, to discuss our portfolio in more detail. Also joining us on the call this morning for Q&A our President, Kevin Collins; our COO, Dave Lyle; and our CFO, Mark Gregson.
Long-term treasury yields ended the quarter sharply higher as the disinflationary trend stalled and market participants dealt with fresh uncertainty regarding the impacts of future monetary, fiscal, and trade policies. Expectations for future inflation reflected in TIPS breakevens rose over the course of the quarter, with the two-year breakeven ending the year at 2.54%, up from 1.77% in September.
This trend has continued into this year as the two-year breakeven is now comfortably above 3%. These uncertainties, combined with the robust labor market, led to a recalibration of the market's expectations for future monetary policy.
Following 100 basis points of reductions in the federal funds target rate over the course of the third and fourth quarters, Fed funds futures market expectations as of year-end 2024, reflected only one to two additional cuts in the target rate through the end of '25. This compares to an expectation of 10 cuts through the end of '25, priced as recently as mid-September.
Against this macroeconomic backdrop, Agency RMBS underperformed treasuries during the fourth quarter. Underperformance during the quarter primarily took place in lower coupons, as a sharp-move higher interest rates limited demand for discount securities.
Although industry volatility moved higher during the quarter, supply-and-demand technicals for higher-coupon agency mortgages were supportive as supply was limited, while bank and overseas demand improved. Prepayment speeds largely remained at low levels, given limited housing activity and elevated mortgage rates.
Premiums on higher-coupon specified pool collateral declined modestly given the increase in interest rates, but remained relatively well supported as implied financing via the dollar roll market for TBA investments remained largely unattractive throughout the quarter.
Agency CMBS risk premiums contracted notably during the fourth quarter, given increased optimism regarding renewed bank demand for stable cash flow profiles amidst elevated interest rate volatility and relatively modest new issuance.
Against this backdrop, book value per common share decreased 4.8% to $8.92 per share and when combined with our $0.40 per share common stock dividend, resulted in an economic return of a negative 0.5% for the quarter.
As mentioned 2025, Agency Mortgage performance has been modestly positive, with interest rate volatility stabilizing as the market's outlook for future monetary policy is coalesced around one or two additional cuts from the FOMC this year. As of February 14, 2025, we estimate our book value per common share to be between $8.90 and $9.26 per share.
We notably improved our capital structure and reduced our cost of capital by funding the redemption of our series B preferred stock in December, primarily with lower-cost repurchase agreements. As a result, our debt-to-equity ratio increased to 6.7 times at the end of the fourth quarter, up from 6.1 times at the end of the third quarter.
At the end of the year, approximately 85% of our $5.4 billion investment portfolio is invested in Agency Mortgages, and 15% was invested in Agency CMBS. And we maintained a sizable balance of unrestricted cash and unencumbered investments totaling $389 million.
Our earnings available for distribution declined from $0.68 in the third quarter to $0.53 in the fourth quarter, as we recognized the one-time charge associated with the redemption of our series B preferred stock. In addition, we diversified the composition of our interest rate hedges, reducing our exposure to changes in swap spreads by increasing our allocation to US Treasury futures.
While this negatively impacted our effective net interest income for the quarter, we stand to benefit from future normalization of the yield curve. In the near term, we remain cautious on Agency Mortgages as shifting expectations for monetary and fiscal policy may result in elevated industry volatility, reducing investor demand.
Our long-term outlook for Agency Mortgages is favorable, however, as we expect demand to improve and higher coupons, given attractive valuations and eventual decline in interest rate volatility and a steeper yield curve.
Lastly, we expect a gradual increase in Agency CMBS new issuance to be met with robust investor demand as the sector continues to offer value relative to other fixed income investments due to its prepayment protection and attractive risk-adjusted return profiles.
Now I'll turn the call over to Brian to go through the portfolio in more detail.

Brian Norris

Thanks, John, and good morning to everyone listening to the call. I'll begin on slide 4, which provides an overview of the interest rate in Agency Mortgage markets. As shown on the chart on the upper left, during the fourth quarter, US Treasury yields rose across the yield curve, with two-year-and-longer maturities increasing between 60 and 85 basis points.
Most of the increase occurred in the first half of the quarter, driven by market expectations of a Republican sweep in the November elections. The chart on the bottom left provides Fed funds futures market pricing since the beginning of 2024. The number of cuts to the Fed funds target rate in 2024 was much less than projected at the beginning of the year, as economic growth, employment, and inflation data proved to be more resilient than anticipated.
The market is now pricing in only one or two cuts in 2025, along with a much higher terminal rate over the next few years. The chart in the upper right reflects changes in the short-term funding rates over the past year. During the fourth quarter, funding rates declined in line with monetary policy easing, but repo rates exhibited some volatility at year-end. Positively, the repo market has normalized since year-end, with one-month Agency MBS repo spreads declining modestly from SOFR plus 20 to SOFR plus 15 basis points.
Lastly, the bottom-right chart details the Agency MBS holdings by the Federal Reserve and US banks. Runoff of the Fed's balance sheet continues, with Agency RMBS declining by approximately $15 billion to $20 billion per month. Quantitative tightening is expected to persist at the current pace in the near term, potentially ending in the second half of 2025.
US banks added nearly $50 billion to their portfolios in the second half of 2024, and we expect bank demand for Agency RMBS to continue at a notable pace as deregulation and steeper yield curve provides an attractive environment for deployment of deposits.
Slide 5 provides more detail on the Agency Mortgage market. In the upper-left chart, we show 30-year current coupon performance versus US Treasury since year-end, highlighting the fourth quarter in gray. Current coupons underperformed during the quarter due to a sharp rise in interest rates. This increase in interest rate volatility reduced investor demand for Agency Mortgages.
In addition, nominal spreads on current coupons were quite volatile in the first half of the fourth quarter, but has stabilized over the last couple of months, due to decreased interest rate volatility and favorable supply-and-demand dynamics. In the chart on the upper right, we show specified pool pay-ups over the past year, which declined since the end of the third quarter as prepayment protection became less valuable as mortgage rates remained elevated.
Lastly, as shown in the lower-right chart, funding via the dollar roll market for TBA securities has improved with implied funding rates lower than SOFR across several coupons. While we continue to prefer specified pools over TBA given their more predictable prepayment behavior, the improvement in the dollar roll market for TBA securities has reduced the difference in returns compared to specified pools fund via repo.
Slide 6 details our Agency RMBS investments and summarizes the investment portfolio changes during the quarter. Our Agency RMBS portfolio decreased 11% quarter over quarter as we sold a portion of our lower-coupon specified pools to manage leverage early in the fourth quarter and to fund purchases in Agency CMBS.
Overall, we remain focused in higher-coupon Agency RMBS, which should see greater benefit from a decline in interest rate volatility, and are largely insulated from direct exposure to assets held by commercial banks and on the Federal Reserve's balance sheet.
We focus our specified pool allocation on prepayment characteristics that are expected to perform well in both premium and discount environments, with our largest concentration in lower loan balance collateral given more predictable prepayments. We increased our allocation to specified pools with low credit score borrowers during the quarter, particularly as we added to higher coupons given the attractive relative value in lower payout stories and higher coupons.
Although we anticipate interest rate volatility to remain moderately elevated in the near term, we believe current valuations on production coupon Agency RMBS largely reflect this risk and continue to represent attractive investment opportunities, with current gross ROEs in the mid- to high teens.
Slide 7 provides detail on our Agency CMBS portfolio. We purchased $181 million at the beginning of the fourth quarter, bringing our exposure to the asset class to approximately 15% of our total investment portfolio. We believe Agency CMBS offers many benefits mainly through its prepayment protection and fixed maturities, which reduce our sensitivity to interest rate volatility.
Gross ROEs on our new purchases were in the low double digits. And we have been disciplined on adding exposure only when the relative value between Agency CMBS and Agency RMBS accurately reflects their different risks. Financing capacity has been robust as we have been able to finance our purchases with multiple counterparties at attractive levels.
We will continue to monitor the sector for opportunities to increase our allocation as they become available, recognizing the overall benefits of the portfolio as the sector diversifies risks associated with an Agency RMBS portfolio. Our Agency CMO allocation is detailed alongside our remaining credit investments on slide 8.
Our allocation to both agency interest-only and credit securities remain largely unchanged, with $71 million allocated to Agency IO and $17 million allocated to credit at quarter-end. Although we anticipate limited near-term price appreciation in these investments, we believe they provide attractive yields for unlevered holdings, with returns in the high single digits.
Slide 9 details our funding and hedge book at quarter-end. Repurchase agreements collateralized by our Agency RMBS and Agency CMBS investments declined from $5.2 billion to $4.9 billion, consistent with a modest decrease in our total assets, while the total notional of our hedges increased from $4.3 billion to $4.7 billion.
The decrease in our repo balance and increase in our hedge notional resulted in a higher hedge ratio for the quarter, from 83% to 95%, reflecting our expectation of fewer cuts in the Fed funds target rate in 2025. The table on the right provides further detail on our hedges at year-end.
We continue to increase our hedge exposures and Treasury futures during the fourth quarter as we sought to decrease our exposure to swap spreads. At year-end, our notional balance of Treasury futures was 30% of the total hedge notional balance, up from 11% at the end of the third quarter.
Slide 10 provides more detail on our capital structure and highlights the improvements made in the fourth quarter subsequent to the redemption of our series B preferred stock. The redemption was funded largely via an increase in repurchase agreements, which have a lower cost of capital than our series B preferred stock. Further improvement in the capital structure remains a focus of ours as we seek to reduce our cost of capital and improve shareholder returns.
To conclude our prepared remarks, financial markets were quite volatile in the fourth quarter as investors began to price in greater monetary and fiscal policy uncertainty. But our focus on higher-coupon Agency RMBS and increased allocation to Agency CMBS mitigated much of this impact and resulted in an economic return of negative 0.5%.
Positively, this volatility has dissipated thus far in 2025, providing a supportive backdrop for our investments and resulting in an increase in our book value of approximately 2%, excluding the dividend accrual as of last Friday. We believe IVR is well positioned to navigate current mortgage market volatility, given our moderate leverage and robust liquidity. We continue to selectively capitalize on historically attractive Agency RMBS spreads, and believe the sector is poised to perform well as interest rate volatility continues to moderate.
Our liquidity position will provide substantial cushion for further potential market stress, while also providing capital to deploy into our target assets as the investment environment improves. In addition, we believe further easing of monetary policy will lead to a steeper yield curve and decline in interest rate volatility, both of which provide a supportive backdrop for Agency Mortgages as they improve demand from commercial banks, overseas investors, money managers, and REITs.
Thank you for your continued support for Invesco Mortgage Capital, and now we will open the line for Q&A.

Question and Answer Session

Operator

(Operator Instructions) Doug Harter, UBS.

Doug Harter

Thanks. Hoping you could talk about how you're viewing kind of the risk-reward trade-off of Agency RMBS and Agency CMBS, especially in light of the current dividend level.

Brian Norris

Yeah, hey, Doug. It's Brian. Yeah, we are -- if you go back to slide 7, you can see when spreads are on Agency CMBS are in kind of high 50s, 60 area, that tends to be relatively attractive versus where mortgages were.
So we did add most of our Agency CMBS exposure kind of at the beginning of the fourth quarter. But as spreads tightened from there, it became a bit less attractive, particularly as Agency Mortgages were underperforming during that time. That difference has certainly compressed here in the first quarter. Agency CMBS spreads are just a touch wider, while Agency Mortgages have performed pretty well.
So I think the benefits that Agency CMBS provides to our portfolio are still supportive. But given that volatility has declined pretty notably here so far in the first quarter, the lean is certainly towards Agency RMBS at the current time.

Doug Harter

Great. And I guess, with that blend and kind of where all spreads are, can you just talk about your comfort in the current dividend level?

John Anzalone

Yeah, Doug, it's John. Hi. Yeah, I mean, obviously, our Board recommends it -- or we recommend our dividend; our Board approves it. That will happen over the next month. But I mean, we look at a number of factors. First and foremost is where our current and near-term to medium-term projected ROEs are on investments. So I mean, that's the first thing.
We also look at where average sort of ROEs have been more historically over a longer timeframe, and then also look at sort of the competitive environment where dividend yields are for that. So I mean, those are all things we're going to be taking a look at as we move over the course of the next month.
But to Brian's point, I think we are pretty selective about where we add Agency CMBS. So we're not adding in much, much lower than where we're seeing Agency RMBS. And it's obviously the ROEs are a little bit lower because they don't have a convexity risk, so they should be a little bit lower. But that's kind of what we're looking at.

Doug Harter

Great. I appreciate the answers.

John Anzalone

Thank you.

Operator

Trevor Cranston, Citizens JMP.

Trevor Cranston

Hey, thanks. On the changes you made to the hedge book this quarter, in the early part of this year, so far, there's been a bit of a reversal in swap spreads.
Can you sort of generally talk about how you guys are thinking about swap spreads going forward, and if you would foresee making any incremental changes to the mix of the hedge position going forward? Thanks.

Brian Norris

Yeah. Thanks, Trevor. It's Brian. Yeah, certainly, there are trade-offs between the two. Given that swap spreads are currently negative, the hedging with them is a bit cheaper. So ROEs are better when you hedge with swaps. But certainly, volatility that we've seen in swap spreads over the past year or two adds more volatility to that hedging as well.
So like I said, at the end of 2024, we were at 30% Treasury futures. I think that's probably the high end given the current environment of where we'd like to be. We have seen swap spreads widen so far in 2025. It's -- swap spreads did tighten a lot in 2024, just given the expectation that Treasury issuance would be substantial as we move forward here.
There's some uncertainty there, I think. A lot of things that have happened so far in 2025 is just that the new administration is maybe a little bit slower to roll out some of the things that were once feared. So you've seen volatility come down. Swap spreads have widened a bit.
So there are trade-offs. Like I said, I think we would target probably 20% to 30% of Treasury futures in the current environment. So we're right in that range currently. So as we move forward, I think we'll still be monitoring swap spreads, obviously. But again, where they are now, I think we're pretty comfortable with where we are.

Trevor Cranston

Okay. Got it. Appreciate the comments. Thank you.

Operator

(Operator Instructions) Jason Stewart, Janney.

Jason Stewart

Hey, good morning. Thanks. I wanted to dig in a little bit more into your cautious outlook on Agency Mortgage. And maybe if you could talk a little bit more about whether that's a rate-driven outlook or if there's a component of GSE reform baked into that cautious outlook? And maybe on the latter, if you do have a view on what's priced into the basis in terms of GSE reform risk, that would be helpful.

Brian Norris

Hey, thanks, Jason. It's Brian. Yeah, I'll tackle GSE reform right out the bat here. I think the market has not reacted at all to the headlines so far that we've seen on that topic. Mortgage spreads have tightened so that -- to the extent that there's any concern out there, it doesn't seem to be reflected.
I think that's notable because the market is essentially saying that the only thing that would really materially impact Agency Mortgage spreads would be a loss of the implicit or explicit guarantee on mortgages. And that remains an extremely remote scenario at this point. So I think spreads have responded accordingly by not pricing in any real concern about that at this current time.
Our cautiousness is -- I mean, like I said, volatility has come down quite a bit in 2025. Mortgage spreads have tightened. So I think there's still a fair amount of monetary and fiscal policy uncertainty out there, trade policy uncertainty.
So I think we're just -- with leverage to our common right around 9%. I think we're comfortable in that situation where spreads are attractive still. We can still earn attractive ROEs, like I said, in the mid- to high teens at that level. So I think we're kind of -- we're not overly cautious.
We still think mortgages will perform well through the year. But just given where we are right now, I think mortgages have had a pretty good start to the year. So it's just a matter of whether volatility will continue to trend lower or if it kind of pauses and goes the other way.

Jason Stewart

Got it. Okay. That's helpful. And then you referenced on the refunding of the series B, moving that to repo. I mean, I guess, the question is a big picture question.
Is the right way to look at -- or how are you looking at preferred today as a part of the capital structure? Is it more permanent capital in your mind? Should we be looking at that as leverage to preferred plus common? Has that shifted the way that you look at the capital structure? Has it shifted over the last year?

John Anzalone

Hey, it's John. Yeah, no, I don't think it's shifted. I mean, we're still -- I think if you look at us historically, our portfolio mix was very different when we had -- when we put on the preferreds. I mean, we had -- there was time we had loans involved. We had securitizations, different asset classes. They made a little bit more sense having preferreds.
And then post-COVID, it just became too much percentage of our capital structure. So I think we're still targeting -- we'd like to get back to the 20%-ish range. I think most of our peers are around that range or -- if not less, even at this point.
So we're still targeting that. So that will be a combination of either growth through ATM or equity issuance or -- and/or continuing to chip away at repurchasing the preferred series Cs.

Jason Stewart

Okay. All right. Thanks, John. Thanks, Brian.

John Anzalone

Thanks.

Operator

Thank you. At this time, we have no further questions. Speakers, I'll hand the call back to you.

Brian Norris

Great. Thank you very much, operator, and thank you, everybody, for joining the call today. Have a great Friday.

Operator

Thank you. That concludes today's conference. Thank you for participating. You may disconnect at this time.