Q3 2025 Earnings Call: Contradictions Emerge on Leverage, Duration, and Investment Strategies

Guidance:

• Management remains constructive on Agency RMBS given lower interest-rate volatility and a steeper yield curve.
• Views near-term risks as balanced after recent outperformance but expects longer-term demand to broaden as QT ends.
• Agency CMBS seen as attractive for diversification and prepayment protection; allocation to be increased selectively when relative value merits.
• Anticipated bank regulatory capital rule changes expected to boost investor demand for agency mortgages and agency CMBS.

Business Commentary:

• Strong Financial Performance and Agency Mortgage Performance:
• Invesco Mortgage Capital reported a positive economic return of 8.7% for the quarter, with a 4.5% increase in book value per common share to $8.41 at quarter-end.

• The performance was driven by strong demand for agency mortgages, which benefited from a supportive environment for risk assets and a decline in interest rate volatility.

• Interest Rate and Yield Curve Trends:

• The difference between 2-year and 30-year treasury yields ended the quarter at 112 basis points, roughly 65 basis points steeper than a year ago.

• This steepening yield curve is supportive of longer-term investments, such as the company's Agency RMBS and Agency CMBS, reflecting market expectations for a more accommodative policy stance from the Federal Reserve.

• Agency Mortgage and CMBS Market Dynamics:

• Agency mortgage performance was impressive during the quarter, with 30-year mortgage rates declining by nearly 50 basis points, impacting higher coupons due to elevated prepayment risk.

• Agency CMBS risk premiums declined quarter-over-quarter, indicating increased investor demand and providing attractive risk-adjusted yields and diversification benefits relative to agency mortgages.

• Capital Structure and Shareholder Returns:

• The company raised $36 million by issuing common stock through its ATM program, maintaining a disciplined approach to benefit existing shareholders.
• Invesco Mortgage Capital continues to focus on reducing its cost of capital and improving its capital structure to prudently maximize shareholder returns, with levered gross returns in the upper teens, in line with its existing dividend level.

Sentiment Analysis:

Overall Tone: Positive

• Company reported book value up to $8.41, a $0.34 dividend and an 8.7% economic return for the quarter; management repeatedly said they 'remain constructive on agency mortgages' and view near-term risks as 'balanced' while citing supportive supply/demand technicals.

Q&A:

• Question from Trevor Cranston (Citizens JMP Securities, LLC): Can you talk about where your net duration exposure is, your position on the shape of the yield curve, and thoughts on potentially using options given the decline in the cost of volatility?
  Response: They're slightly long on model duration (vs historically flat), reduced steepener exposure by shifting hedges toward the front end, and currently prefer interest-rate swaps while monitoring swap spreads before adding treasury futures or other tools.

• Question from Trevor Cranston (Citizens JMP Securities, LLC): With the tightening in agency spreads last quarter, where are you seeing returns on marginal capital deployment relative to the existing dividend level?
  Response: Levered gross returns were in the upper teens and net returns in the mid-teens, which management says are broadly consistent with and supportive of the current dividend-to-book yield.

• Question from Douglas Harter (UBS Investment Bank): What's your appetite for continuing to change the capital structure with preferred buybacks and common activity, and did those transactions impact book value this quarter?
  Response: Preferred buybacks were small (~$2M) with minimal impact on book value; no recent common issuance due to a persistent discount and management isn't repurchasing common now because current investment opportunities are accretive—they'll consider buybacks if price-to-book is persistently low and investments aren't accretive.

• Question from Douglas Harter (UBS Investment Bank): How are you seeing relative value between Agency CMBS and Agency RMBS today?
  Response: Agency RMBS currently offers more attractive ROE (mid/upper teens); Agency CMBS returns align more with lower-coupon RMBS and are retained for diversification and convexity—they'd add CMBS only if relative value compresses further.

Contradiction Point 1

Leverage and Dividend Coverage

It involves changes in the company's strategy regarding leverage and dividend coverage, which are crucial for financial stability and investor expectations.

What is your leverage comfort level? Are there any upcoming events that could impact your capacity to increase leverage? - Trevor Cranston(JonesTrading)

2025Q3: We're comfortable at the current level, with spreads wide enough to cover dividends. We're not looking to increase leverage now, as there's still uncertainty about monetary policy and tariffs' impact. But as the Fed cuts rates, mortgage spreads may tighten, providing an environment for potentially increasing leverage. - Brian Norris(CIO)

What is the outlook for core earnings and their impact on the dividend? - Marissa Lobo Nelson(UBS)

2025Q2: ROEs are attractive, and we expect spreads to remain wide due to technical reasons like Fed runoff and quiet banks. We don't anticipate a significant change in our leverage, which is already at the optimal level to cover dividends. - Brian Norris(CIO)

Contradiction Point 2

Yield Curve Positioning and Duration Exposure

It involves the company's strategic positioning regarding the yield curve and duration exposure, which impacts potential investment returns and risk management.

Can you discuss your net duration exposure and your general stance on the yield curve shape? How are you considering using options in your hedge portfolios given the decline in volatility costs? - Trevor Cranston(Citizens JMP Securities, LLC, Research Division)

2025Q3: We kind of had a bit of a steepener on a while now. And we started to reduce that a little bit, preferring to move more of our hedges into the front end of the curve. - Brian Norris(CIO)

Can you explain the decision to reduce leverage and how you manage leverage during volatile periods—whether to let it float or take portfolio actions? - Doug Harter(UBS)

2025Q1: We let leverage float up to a point, but acted when it reached the high end of the range to reduce risk and maintain liquidity. - Brian Norris(CIO)

Contradiction Point 3

Inflation Risks and Monetary Policy Adjustments

It involves the company's view on inflation risks and potential adjustments in monetary policy, which affects investment strategies and market outlook.

Where is your net duration exposure? Do you have a general position on the yield curve's shape? Are you considering using options in your hedge portfolios due to the drop in volatility costs? - Trevor Cranston(Citizens JMP Securities, LLC, Research Division)

2025Q3: And so we do think that we have a little bit more risk towards a rally in interest rates. - Brian Norris(CIO)

How does the opportunity in Agency today compare to the previous spread peak in October last year? - Jason Weaver(JonesTrading)

2025Q1: Spreads are attractive, consistent with previous widening episodes. However, we are more cautious due to potential inflation risks delaying monetary policy adjustments. - Brian Norris(CIO)

Contradiction Point 4

Appetite for Agency CMBS vs Agency RMBS

It involves changes in investment preferences between Agency CMBS and Agency RMBS, which directly impacts the portfolio composition and potential returns.

How do you assess the relative value between Agency CMBS and Agency RMBS today? - Douglas Harter (UBS Investment Bank, Research Division)

2025Q3: Yes, I mean, Agency RMBS continues to provide a more attractive ROE. I think Agency CMBS, like I said in my comments, the return potential there is a bit more in line with what we would call lower coupon Agency RMBS and continues to have a lot of benefits. - Brian Norris(CIO)

How do you assess the risk-reward trade-off for Agency RMBS and CMBS given current dividend levels? - Douglas Harter (UBS)

2024Q4: Brian Norris: We added Agency CMBS exposure at the beginning of the fourth quarter when spreads were in the high 50s and 60 area, which was relatively attractive compared to mortgages. However, as spreads tightened and Agency Mortgages underperformed, the benefit of Agency CMBS became less attractive. - Brian Norris(CIO)

Contradiction Point 5

Hedge Position and Swap Spreads

It involves changes in the hedge position strategy, particularly regarding the use of swap spreads, which affects the portfolio's risk management and potential returns.

Where is your net duration exposure? Do you have a position on the yield curve's shape? Are you considering using options in hedge portfolios due to the decline in volatility costs? - Trevor Cranston (Citizens JMP Securities, LLC, Research Division)

2025Q3: We still think that there's, we still have a bit of widening to do in there. So we'd like to lean more heavily into swaps. - Brian Norris(CIO)

Can you discuss your outlook on swap spreads and whether you anticipate incremental changes to the hedge position mix in the future? - Trevor Cranston (Citizens JMP Securities, LLC, Research Division)

2024Q4: Brian Norris: Swap spreads are currently negative, making hedging with them cheaper, but they add volatility. We increased our allocation to U.S. Treasury futures up to 30% during 2024. - Brian Norris(CIO)