Welcome to the Invesco Mortgage Capital's Second Quarter 2025 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 . Mr. Seals, you may begin the call. Greg Sea

Thanks, operator, and 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, invescomortgagecapital com. This information can be found by going to the 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 nor 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 Invesco's -- IVR's CEO, John Anzalone. John?

Thank you, and good morning, and welcome to Invesco Mortgage Capital's second quarter earnings call. I'll provide some brief comments before turning the call over to our , Brian Norris, to discuss our portfolio in more detail. Also joining us on the call this morning for Q&A is our President, Kevin Collins; our COO, Dave Lyle; and our CFO, Mark Gregson. Financial conditions were quite volatile during the second quarter, initially driven by a sharply negative reactions to tariff announcements on April 2, which triggered a spike in interest rate volatility and a broad repricing of risk assets. Despite the early turbulence, financial conditions ended the quarter modestly accommodative as interest rate volatility declined and most risk asset valuations rebounded following the announcement of a delay in tariff implementation. Even with relatively stable inflation data during the quarter and the potential impact of higher tariffs, investor expectations for inflation have moderated, as reflected in lower breakeven rates on treasury inflation-protected securities. This shift partly reflected growing concerns about the long-term effects of trade policies and economic growth. Meanwhile, labor market data continues to signal resilience, as the economy added about 150,000 jobs per month during Q2, and the unemployment rate held steady at 4.1%. As the quarter progressed, stable employment data and declining recession risk led to a moderation in market expectations for near-term monetary policy action. Federal Funds Futures market expectations now reflect approximately 2 rate cuts by year end, an additional 2 to 3 cuts in 2026. Interest rates declined across the front end of the yield curve -- of the treasury yield curve during the second quarter, while long-end rates moved higher, reflecting expectations for accommodative policies from the FOMC alongside concerns about potential increases in treasury issuance over the coming years. As a result of the spike in interest rate volatility and broad sell-off in risk assets, agency mortgage has sharply underperformed treasuries in April. However, following the announced delay in tariffs, interest rate volatility subsequently declined in May and June and ended the quarter modestly below its starting level. Performance in agency mortgages and Agency CMBS along with broader risk assets, followed a similar trajectory, recovering meaningfully by quarter end after a weak start in April. Finally, valuations on our interest rate swap hedges were negatively impacted as trade policy-related volatility combined with fiscal policy concerns drive swap spreads noticeably tighter. These factors resulted in an economic return for the quarter of negative 4.8%, consisting of our $0.34 dividend per common share and a $0.76 decline in our book value per common share. Our debt-to-equity ratio decreased from 7.1x at the end of March to 6.5x at the end of June, reflecting our belief that elevated near-term uncertainty regarding trade and monetary policy warrants a modestly more defensive posture. At quarter end, our $5.2 billion investment portfolio consisted of $4.3 billion in agency mortgages and $900 million Agency CMBS, and we maintained a sizable balance of unrestricted cash and unencumbered investments totaling $362 million. As of July 18, 2025, we estimate book value per common share to be between $7.99 and $8.31, as agency mortgages and Agency CMBS both performed well into the beginning of the third quarter. While our near-term outlook remains cautious, our long-term outlook for agency mortgages is favorable, as we expect demand to improve in higher coupons given attractive valuations, continued stabilization in interest rate volatility and a steeper yield curve. In addition, we remain positive on Agency CMBS as limited issuance, strong fundamental performance and stable cash flow profile should provide favorable support for this sector. Now, I'll turn the call over to Brian for more details.

Thanks, John, and good morning to everyone on the call. I'll begin on Slide 4, which provides an overview of the interest rate and agency mortgage markets over the past year. During the second quarter, the U.S. treasury yield curve steepened as financial markets adjusted to increased uncertainty regarding trade, monetary and fiscal policy. Futures markets priced in additional monetary policy easing amid softening U.S. economic growth expectations and persistent trade policy uncertainty, pushing short-term yields lower. In contrast, expectations for a sizable fiscal package and potential tariff-driven inflation pressures lifted long-term yields. While the 10-year treasury yield was little changed over the quarter, the 2-year yield declined 16 basis points, and the 30-year yield increased 30 -- or 20 basis points. This steepening brought the June 30 spread to its steepest level in nearly 3.5 years. As depicted in the chart on the bottom left, as of June 30, Fed Funds Futures now anticipate 5 to 6 cuts by the end of 2026, 1 more cut than they were pricing in as of March 31 and nearly 4 more cuts than were priced in a year ago. The chart in the upper right reflects changes in short-term funding rates over the past year. Positively, the funding market for our assets remained relatively stable due to the volatility in April, with financing capacity robust, haircuts unchanged and 1-month repo spreads remaining between SOFR plus 15 to 18 basis points. Lastly, the bottom right chart details agency mortgage holdings by the Federal Reserve and U.S. banks. As announced by the FOMC at its March meeting, the Federal Reserve began reducing the pace of balance sheet runoff in April. Treasury runoff declined from $25 billion to $5 billion per month, while the cap on Agency RMBS run-off remained unchanged at $35 billion per month. However, actual Agency RMBS runoff has consistently ranged between $15 billion to $20 billion per month since early 2023, well below the stated cap. Given the reduced pace of treasury run-off, quantitative tightening is now expected to conclude in 2026, a year later than previously expected. U.S. banks essentially reinvested paydowns in the second quarter, but we expect bank demand for Agency RMBS to increase in the second half of the year as deregulation, a steeper yield curve and further easing of monetary policy provides an attractive environment for deployment of deposits and to securities. Slide 5 provides more detail on the agency mortgage market. In the upper left chart, we show 30-year current coupon performance versus U.S. treasuries over the past year, highlighting the second quarter in gray. The quarter began with a sharp decline in valuations as interest rate volatility spiked higher in response to trade policy developments, leading to a broad sell-off in financial markets. However, interest rate volatility declined notably after the 90-day pause in tariff implementation and trended lower through the end of the quarter, providing an attractive environment for risk assets, as the uncertainty regarding trade and fiscal policy diminished. Performance across the 30-year coupon stack rebounded with most coupons ultimately outperforming treasury hedges by a modest 20 to 30 basis points for the quarter. However, carry trade unwinds and fiscal uncertainty resulted in significantly tighter swap spreads on the quarter, resulting in negative hedge returns for agency mortgages versus swaps despite their modest outperformance relative to treasuries. Positively, specified pool pay-ups rebounded from April's poor performance to end the quarter largely where they began, while funding via the dollar roll market for TBA securities remain largely unattractive for most 30-year coupons. Overall, we prefer specified pools over TBA, given more attractive and stable funding and a more predictable prepayment behavior, but we will continue to take advantage of attractive alternatives in the dollar roll market when available. Slide 6 details our Agency RMBS investments and summarizes investment portfolio changes during the quarter. Our Agency RMBS portfolio decreased 15% quarter-over-quarter, as we managed risk in the beginning of April as markets navigated trade policy uncertainty. We sold higher coupons, low pay-up specified pools given their elevated sensitivity to potential increases in interest rate volatility. Despite the sales in April, we remain focused in higher coupon Agency RMBS, which benefit from more attractive valuations and an expected further decline in interest rate volatility, while demand from banks, overseas investors and mortgage rates should offset supply through year-end. We continue to 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 relative to lower payout pools. Although we are cautious on Agency RMBS overall in the near term, given recent outperformance and the potential for a modest reversal in the trend of lower interest rate volatility, we believe levered gross ROEs in the low 20s on higher coupons represent a very attractive entry point rates to mortgage investors with longer investment horizons. Slide 7 provides detail on our Agency CMBS portfolio. Given the sharp underperformance in Agency RMBS in April, the relative value between Agency CMBS and Agency RMBS became unattractive, which resulted in no new purchases for the quarter. However, despite the lack of new purchases, the decline in our Agency RMBS portfolio caused a modest increase in our allocation to Agency CMBS for the overall portfolio, which increased from 15% at the end of the first quarter to just over 17% as of June 30. We believe Agency CMBS offers many benefits, mainly through its prepayment protection and fixed maturities, which reduced our sensitivity to interest rate volatility. Levered gross ROEs are in the low to mid-teens, and we have been disciplined on adding exposure only when the relative value between Agency CMBS and Agency RMBS accurately reflects their unique risk profiles. Financing capacity has been robust, as we continue to finance our purchases with multiple counterparties at attractive levels. We will continue to monitor the sector for opportunities to increase our allocation, as the relative value becomes attractive, recognizing the overall benefits of the portfolio as the sector diversifies risk associated with the Agency RMBS portfolio. Slide 8 details our funding and hedge book at quarter end. Repurchase agreements collateralized by our Agency RMBS and Agency CMBS investments declined from $5.4 billion to $4.6 billion, consistent with the decrease in our total assets, while the notional of our hedges declined from $4.5 billion to $4.3 billion, as we actively increased our hedge ratio from 85% to 94%. The table on the right provides further detail on our hedges at quarter end. Our composition of hedges remained largely unchanged quarter-over-quarter, approximately 80% of our hedges, consisting of interest rate swaps on a notional basis. While on a dollar duration basis, the allocation remained near 70% given a higher allocation to interest rate swaps at the front end of the yield curve. Our allocation to interest rate swaps negatively impacted book value during the second quarter as carry trade unwinds and heightened concerns over fiscal policy led to sharply tighter swap spreads, ranging from 6 basis points tighter in the front end to 10 to 12 basis points tighter in the long end. Slide 9 provides detail on our capital structure and highlights the improvements we've made in recent quarters to reduce our cost of capital. Further improvement in the capital structure remains a focus of our management team, as we seek to maximize shareholder returns. To conclude our prepared remarks, financial market volatility increased sharply at the beginning of the second quarter amidst heightened trade policy uncertainty, but declined notably after the 90-day pause in tariff implementation on April 9. From that point, volatility generally trended lower through quarter end, providing a supportive backdrop for risk assets, which rebounded after sharp underperformance in early April. Agency RMBS ultimately modestly outperformed treasury hedges on the quarter, but underperformed swap hedges given significant tightening of swap spreads. Although increased volatility, swap spread tightening and agency mortgage underperformance negatively impacted our book value in April. Positively, financial markets have since stabilized. And as of July 18, we estimate our book value per share to be up a little more than 1% since the end of the second quarter. We believe our liquidity position provides substantial cushion for further potential market stress while also providing capital to deploy into our target assets as the investment environment improves. While near-term uncertainty warrants a somewhat cautious approach, we believe further easing of monetary policy will lead to a steeper yield curve and an eventual further decline in interest rate volatility, both of which will provide a supportive backdrop for agency mortgages over the long term, as they should result in increased demand for commercial banks, overseas investors, money managers and mortgage REITs. Thank you for your continued support for Invesco Mortgage Capital, and now, we will open the line for Q&A.

[Operator Instructions] Now our first question is from Jason Weaver with JonesTrading.

Brian, maybe for you first. Taking your comments into account on the preference for high coupon RMBS here, how do you think about the relative risk versus reward just due to the possible lower rates, prepayment exposure? And I think 6s have -- TBA 6s have about 1 point of premium, 6.5 is about 3 points. So how do you think about relative value here?

Yes. Thanks, Jason. I think the spreads accurately kind of reflect that risk. And so we see notably wider spreads, nominal spreads in higher coupons. And we think that, that will help kind of cushion any potential increases. We did reduce our 30-year 6.5% exposure during the quarter. And that's largely reflective of kind of what you're talking about there. I think 6.5% and higher are probably a bit more exposed than the rest of our coupon stack. So, yes, I think our allocation to specified pools certainly addresses that as well. So we have a fair amount of low balance exposure in those coupons as well as some of the other stories that help protect us. So we don't own any TBA as of quarter end. So I feel like we're pretty well protected to the extent that we do see notably lower rates. Our expectation is that, at least our house view is that, the Fed will cut a couple of times here at the end of 2025, and then, a few more times in 2026. But really, I think -- we think that, that will result in just a notably steeper curve and not necessarily a significant decline in tenure, which is where kind of the mortgage rate is keyed off of. So we're not anticipating a significant decline in mortgage rates here. So we think that certainly 5, 5.5, 6s are still pretty well inflated just given the prepayment protection that we own in the tariff pools.

Got it. And -- I mean, you mentioned a lot of sort of risk events are seemingly behind us. Obviously, the amount of monetary easing is still very much in question here. What's your -- right now, what's your comfort zone on leverage? And any sort of events upcoming that may affect your ability to take that higher?

Yes. I mean, we're certainly pretty comfortable. I think, we're about a half a turn lower than where we were during the first quarter. And the good news is that with spreads as wide as they are, particularly versus swaps, gross ROEs are very attractive, certainly able to cover the dividend from an earnings perspective. And so we don't feel like we need to take leverage higher in order to meet kind of our goals from a return perspective. And so we're very comfortable with where we are right now. Certainly, tail risk events have declined -- or the potential for tail risk has declined over the course of the second quarter. So as we move into the third quarter, we still think that there are -- there's still a fair amount of uncertainty about monetary policy, and ultimately, kind of as tariffs are starting to kind of hit the economy here in the third quarter more substantially, the impact that, that will have on inflation and the direction of monitoring policy as well. So we're pretty comfortable with where we are. As -- I think, as the Fed starts to cut and that path becomes a bit more certain, what we'll probably see is rate fall will come down, mortgage spreads will tighten a little bit and then that would provide kind of more of an environment that we could potentially take leverage a little bit higher.

Our next question now is from Trevor Cranston with Citizens JMP.

You talked about the impact of spot spreads, obviously, in the second quarter. Could you give us an update on your sort of outlook for how you think swap spreads are likely to behave going forward? And how that relates to your comfort level around kind of the mix of hedges you guys currently have in place?

Yes. Trevor, it's Brian. Yes, I think -- certainly, I mentioned we're kind of 80% notional on interest rate swaps relative to treasury futures. And I think that's reflective of kind of our stance on where swap spreads are right now. I think that, that -- certainly, from an ROE perspective, it's very attractive to hedge with swaps at this point. And we think that the ultimate direction of swap spreads will be wider, which will be beneficial as well. And so we're probably at max kind of allocation to interest rate swaps. And as we see the environment start to normalize, and we would move more into treasury futures, what that ultimate level looks like is a bit uncertain at this point. But we kind of think that ROEs are very attractive now hedging the swaps, and the direction -- the anticipated direction of swap spreads is wider. So that's also beneficial. So we're kind of at our max allocation to swaps. And then, as that changes, we would rotate a little bit more in the futures.

Our next question now is from Doug Harter with UBS.

It's actually Marissa Lobo on for Doug. I was hoping you could speak to your views on the trajectory of core earnings and what it means for the dividend.

Yes. Like I said, I mean, I think ROEs are very attractive at this moment, so we don't really anticipate -- I think mortgage spreads, generally speaking, have been wide for a while, and that's been very supportive of the earnings of the portfolio. And there's a lot of different reasons for that. There's technical reasons. Clearly, the Fed has been running off their portfolio for a couple of years now. Banks have been notably quiet over the last couple of years as well. And so we don't anticipate that dynamic changing considerably. Banks will likely start to add here, but the Fed is going to continue to roll off. And money managers have been overweight for a while now as well. And so they're really dependent on flows. And so we kind of think that spreads should be relatively attractive for quite a long period. And so we anticipate, like I said, leverage is where it needs to be in order to produce the earnings that we are comfortable with. And so we don't really anticipate that changing in the near term.

Our next question now is from Jason Stewart with Janney Montgomery Scott.

So conceptual question here in terms of leverage and total return. I think from my perspective, I would expect leverage to move higher when the return opportunities are the highest. But it kind of sounds like you're managing this to cover the dividend and mitigate risk. Is that -- am I thinking about that the right way? I mean, otherwise, would you not want to increase leverage when total return opportunities are the highest and reduce it the opposite way?

Jason, it's Brian. Yes, I mean it's certainly -- every environment is different. And so it's challenging to kind of make a blanket statement like that. I think, ultimately, when spreads are the widest and ROEs are the most attractive, that is also -- there's reasons for that, right? There's heightened uncertainty, heightened interest rate volatility. And so it's really just kind of managing within that environment as it comes up. I think you're right. I mean, as ROEs become even more attractive than it would behoove us to increase our leverage in that scenario. But also what happens is, as spreads are widening, book value is likely declining and leverage is increasing on its own. So it's really just kind of a -- it's a fine line, but it's a balancing act between trying to take advantage of opportunities as they arise without taking risk beyond where we're comfortable.

Right. And it's not all leverage either. I mean, because we -- as Brian mentioned, we are more exposed to swap spreads now because swap spreads are very wide, so there's places to do that without necessarily increasing leverage.

Yes. Okay. And then just, Brian, on your -- I missed part of this, levered gross ROEs, is that based on a coupon or on a blended on a portfolio basis? You said low 20s, but I missed if it was blended or on a coupon.

Yes, on higher coupons, kind of probably 5.5% to 6% and 6.5%.

Okay. And then so your point is with leverage where it is today in higher coupons, given your swap book, you feel comfortable on a carry basis earning the dividend, so I get that. And then from a -- just another conceptual question from a total return versus carry standpoint, is it fair to say that you're leaning more towards carry rather than total return at this point? Is that the driving factor of how you're allocating on the asset and the liability side or the hedge side?

Yes. I think that mortgage spreads and mortgages have performed pretty well, certainly since April. And that's because interest rate volatility has trended lower during that time. And so -- and at this point, without banks coming back, which doesn't appear to be a real near-term event. I think notable tightening from here is limited. So that also kind of plays into us looking at this more as a carry trade at this point until we get a little bit more clarity on the path of monetary policy and the impact of tariffs.

Now our last question today is from Eric Hagen with BTIG.

I actually have a question on the CMBS position. I mean, how do you guys feel like CMBS spreads could behave when the Fed cuts rates? Or do you think there's a lot of room for spreads to tighten in that market anymore? And do you feel like conditions in the repo market are stable enough to handle a spread widening event, the CMBS market?

Sure. Yes, I'll take the last one first, I think. Financing market for that -- for Agency CMBS has been robust, even probably better than what we initially anticipated when we started investing. And so we have no real concerns about that market deteriorating in a widening event. It did not in early April. So we feel very, very comfortable about that. And the first question, Agency CMBS spread, I think for the most part, they kind of follow lower coupon Agency RMBS spreads, but with a lower beta. So we feel, again, pretty comfortable there. We do think that as the Fed starts to cut and Agency RMBS likely tightens as a result of that, that we'll see Agency CMBS follow suit as well.

Got it. Is the CMBS position a fully levered position? Or is there any liquidity that you can draw from that position at this point?

Yes. I mean, it's levered to the extent that the rest of our book is performing well.

As that was our last question, I now would like to turn it back to the management for any closing remarks.

Well, yes, I'd like to just thank everyone for joining us on the call, and we look forward to talking again next quarter. Thanks.

That concludes today's event. Thank you for your participation. You may please disconnect at this time.