IVR
#Thanks, <UNK>.
We are pleased to have generated attractive economic returns to our shareholders in 2016 as well as over the last three- and five-year periods in absolute terms and relative to our peers.
I'm also excited about the future of IVR due to our very strong team, which will now be led by <UNK> <UNK>.
Many of you are aware that several months ago, we announced my retirement and <UNK>'s elevation from Chief Investment Officer to become the Company's new CEO.
<UNK> has served as our CIO since the Company's inception and is well equipped as he has keen instincts for value and timing in our markets, and of course, he has a very eminent understanding of IVR in a 25-year carrier in real estate debt markets.
He is highly familiar to many of you as well as he has been a very visible figure representing IVR at numerous analyst and investor events along with being a consistent contributor to this quarterly call and other public forums.
<UNK> enjoys a strong endorsement by our Board, from me personally, and I am delighted he is our new CEO.
Our shareholders can look forward to benefiting from <UNK>'s guidance and his commitment to working in their best interest.
Let me say thank you now to the team here for a job well done and to you, our shareholders, for the faith you've placed in us since 2009.
And now, I introduce our incoming CEO, <UNK> <UNK>.
Thanks, <UNK>.
First of all, on behalf of the team, I would like to thank <UNK> congratulate him on his retirement.
We obviously wouldn't be where we are right now without his leadership over the last 7.5 years.
While <UNK>'s departure is going to leave a big hole to fill, we have an extremely deep and talented team that will meet the challenge.
I am honored to have the opportunity to continue his legacy of working for our shareholders and delivering on our commitments.
I would like to highlight the individuals that have been elevated within the Company and will be taking on expanded roles.
Beginning officially on March 1, Rob Kuster, our Chief Operating Officer, will become President and Chief Operating Officer.
<UNK> <UNK>, our Head of the Mortgage Backed Security Portfolio Management at Invesco, will become our Chief Investment Officer.
And Dave Lyle and Kevin Collins, our Heads of Residential Mortgage Backed Securities and Commercial Backed Securities Credit at Invesco, will become Executive Vice Presidents in charge of Residential and Commercial Credit, respectively.
This group has worked closely together since IVR's inception in June of 2009, so we anticipate this transition should be seamless.
As for today's call, I'll provide some brief remarks about the quarter, and then I'll give the floor to <UNK> <UNK> who will talk about our portfolio in greater detail before opening the call to Q&A.
IVR's economic performance has been strong during 2016.
Despite a slight negative economic return of minus 1.1% during the fourth quarter, IVR's overall economic return for 2016 was a robust 11.3%, which compares very favorably to our peers, and you can see that on slide 5.
Going into the fourth quarter and throughout most of 2016, we sought to actively reduce the risk profile of our portfolio in anticipation that the market might experience heightened volatility caused by the presidential election, the potential for the FOMC to increase the fed funds rate, and the ongoing Brexit negotiations.
You'll notice that we've reduced the overall size of the portfolio and have been biased to add shorter duration agencies.
This [prove proved pression] as the markets were quite volatile during the fourth quarter after the largely unexpected result of the US presidential election, followed by the FOMC's decision to increase the fed funds rate by 25 basis points in December.
We saw interest rates rise sharply and yield curve steepen meaningfully.
As the market priced in a high probability, the new administration will quickly enact fiscal stimulus, tax cuts, and regulatory reform.
Risk markets reacted favorably as equities rallied and spreads on credit assets tightened nearly across the board while longer duration ADC spreads had trouble keeping up with the sharp move in rates.
During the fourth quarter, our core EPS was $0.36 per share.
Our reduced core earnings number was largely a result of our conservative positioning, lower leverage, faster-than-expected prepayment speeds, and increased funding costs after the FOMC and into year end.
As we head into 2017, all of these headwinds have reversed, and we expect our core run rate to recover to levels more in line with our current dividend.
We observed a material slowdown in prepayment speeds recently as the impact of higher rates makes refinancing less attractive.
Repo rates have decreased as the year-end balance sheet pressures on our counterparties have [eased].
And because we were conservatively positioned, we've plenty of dry powder to redeploy capital into investments in a more favorable environment where rates are higher and yield curve is steeper.
While our more conservative stance led to a temporary reduction in our core run rate, it also helped to protect our book value.
For the quarter, our book value was down 3.3% to $17.48, while for the full year, our book value increased by 2%.
This is despite the 10-year treasury rate rising by 84 basis points during the quarter and 18 basis points during the year with the trading rates of 124 basis points from peak to trough.
While spreads in our credit assets tightened during Q4, this was not enough to offset the widening of agency spreads that occurred.
Since year end, rates have traded in a much narrower range, while credit spreads continued to tighten, and our current book value is up approximately 2% year to date.
Looking forward to 2017, we believe we are very well positioned for the uncertain environment that we now face.
While the risk markets have priced in a high probability that fiscal stimulus, tax cuts, and regulatory reform will have a positive impact on the economy, none of these are sure things, and even if they happen, the timing is quite uncertain.
On the flip side, we believe the market may be underestimating the risks of protectionist trade policies, and the chaotic news flow out of Washington.
As such, we remain cautious on adding additional credit assets at these valuations.
Our credit portfolio is highly seasoned and high quality and has benefited from the rallying of risk assets, but we are waiting for a more opportune time to deploy capital out of liquid agency's securities.
While the opportunities in credit are limited currently, we have taken advantage of the wider spreads on third-year ADCs and the greater hedged ROEs they generate and have increased our earning assets during the first quarter.
This should also increase our earnings power going forward while preserving our ability to be ready to capitalize on opportunities as they become available.
I'll stop here and let <UNK> talk about the portfolio in more detail.
Yes.
I will start and <UNK> can add in.
I think that we view it as ---+ we're always evaluating the different asset classes against each other for risk return.
For the first time in a long time, we have seen agency ROEs in the, call it 12% to 13% range hedged and with rates 100 basis points higher essentially, the convexity profile looks better.
Right now, that looks like the most attractive place to go.
We still have a lot of assets in shorter duration, agencies also, and hybrid ARMS in 15 years.
And also, we have a lot of legacy, especially on the residential side, a lot of legacy assets that continue to pay down that we need to redeploy also.
I would say going forward, we think right now agencies look best but if we do see credit opportunities, we have plenty of dry powder to make that happen.
I think at current spread levels, we are still comfortable holding, and that is primarily based on our fundamental view in both residential housing and commercial credit.
Certainly, there is spread levels where you would likely become a seller, but I think if we were to get another ---+ significantly [like] tighter, we might start to consider potentially selling.
Or if our fundamental view deteriorated at all, we might consider selling.
But so long as our fundamental review remains relatively positive, we'll probably continue to hold our current position and look for opportunities to add when we find bonds that make sense.
But to summarize, though, clearly there will be a spread level if we continue to tighten where we may start to lighten up and move into agencies or other sectors that might appear attractive or have lagged with tightening.
There is no hard limit really to [tending] the sector subject to the REIT rules, but agency MBS are the most friendly relative to the whole pool test.
So, no.
There is no effective limit for agency exposure.
I think that reflects just dollar prices on the bond duration (multiple speakers).
Our average duration on our CMBS book is probably five to six years, so you get 85 basis point move in rates, and that's going to have a pretty significant impact.
So we did see spread tightening but not enough to offset just the pure duration move there.
When we break that out, the slots are separate so they are not attached to the assets they are hedging in that [stable].
We really haven't.
I would say our expectations are not very far off of market with potentially two to three moves by the Fed.
We do think on the longer end, though, we could establish a higher trading range here.
Certainly, the expectations for fiscal policy have driven this reflation or Trump trade but you kind of see tax reform continues to be pushed off for other more pressing matters.
You've got issues in the EU with Greece in the headlines again and Le Pen gaining momentum.
And we do see a lot of continued factors that could hold the long end lower and potentially call into question how many times the Fed moves.
Right now if the data continues on its current trajectory barring any [allergic] at risk, I think two to three probably is the right answer, but certainly we do see some risk go up there that could call that into question.
You're welcome.
