Invesco Mortgage Capital Inc. 2026 Q3 Earnings 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 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. 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. 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 basis points, 10-year yields rise more than 80 basis points, 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. 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%. Collectively, these developments, 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.

I would call Agency CMBS spreads modestly wider. Against this backdrop, we generated an economic return of negative 11.6%. 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.

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. Our EAD, it declined from $0.50 in the second quarter to $0.47 in the third quarter. That largely reflected the impact of repositioning our swap portfolio. As of quarter end, we hedged 99% of our borrowing costs with interest rate swaps and U.S. Treasury futures. 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. 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. 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. 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.

Hey, thanks, Kevin. Good morning to everyone listening to the call. I will 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-target 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 a 25 basis point increase in the Fed funds rate at their September 16th meeting. The increase was the committee's first since July 2023, and following the meeting, the market priced in nearly four more 25 basis point increases for 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 the 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 one-month SOFR for much of the quarter, enhancing levered return potential in those coupons. Higher mortgage rates, however, weighed on specified pool pay-ups 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%-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.