Invesco Mortgage Capital Inc. — Q3 2019 Form 10-Q
Business context and period. Invesco Mortgage Capital is an externally managed mortgage REIT investing in agency and non-agency mortgage securities, credit-risk-transfer securities and mortgage-related assets. This unaudited filing covers the quarter and nine months ended September 30, 2019; comparisons are with the corresponding 2018 periods unless noted.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Interest income | $196.3 million | $162.1 million | $585.6 million | $466.9 million |
| Interest expense | $123.3 million | $91.3 million | $365.5 million | $237.2 million |
| Net interest income | $73.0 million | $70.8 million | $220.1 million | $229.7 million |
| Net income (loss) attributable to common stockholders | $77.9 million | $(64.5) million | $212.8 million | $57.0 million |
| Basic EPS | $0.57 | $(0.58) | $1.66 | $0.51 |
| Core earnings per share, non-GAAP | $0.47 | $0.41 | $1.40 | $1.27 |
Margins and earnings quality. GAAP net interest margin was 1.20% in both the Q3 and nine-month 2019 periods, versus 1.24% and 1.43%, respectively, in 2018. Nine-month core earnings attributable to common stockholders were $179.7 million, up from $142.1 million. GAAP results were strongly affected by fair-value movements: Q3 investment gains of $202.4 million were partly offset by derivative losses of $177.2 million; for nine months, investment gains of $773.0 million were largely offset by derivative losses of $723.4 million. The company said investment gains reflected lower rates and tighter spreads, while hedge losses primarily reflected falling rates.
Balance sheet and liquidity. At September 30, 2019, total assets were $24.06 billion, including $23.60 billion of mortgage-backed and credit-risk-transfer securities. Total equity was $2.91 billion; book value per common share was $16.31, up 6.8% from $15.27 at December 31, 2018. Cash, cash equivalents and restricted cash totaled $206.0 million. Repurchase agreements were $18.07 billion and secured loans were $1.65 billion, for total borrowings of $19.72 billion. The reported total debt-to-equity ratio was 6.8x and the repurchase-agreement debt-to-equity ratio was 6.9x.
For the first nine months, operating activities provided $217.9 million of cash, investing activities used $4.90 billion, and financing activities provided $4.76 billion. Common stock issuance generated approximately $486.5 million in cash. The company reported a $1.3 billion investment-related payable primarily associated with Agency CMBS TBA securities expected to settle mainly in Q4.
Material changes versus comparable periods
- Q3 common-stockholder earnings swung from a loss to a profit, primarily because investment fair-value results improved substantially, despite losses on derivatives.
- For the first nine months, net interest income declined $9.6 million year over year as borrowing costs increased faster than interest income. Average earning assets rose to $20.3 billion from $18.1 billion, while average cost of funds rose to 2.64% from 2.02%.
- The investment portfolio expanded to $23.69 billion from $17.51 billion at year-end 2018. Agency CMBS increased to about 21% of the portfolio from 6%; the company also sold most of its Hybrid ARM securities.
- Borrowings increased to $19.72 billion from $15.25 billion at year-end. The company completed two common-stock offerings in 2019 and issued additional shares through its at-the-market program; outstanding common shares rose to 142.8 million from 111.6 million.
- Weighted average CPR increased to 14.1% at quarter-end from 9.0% at June 30, 2019, increasing exposure to faster prepayments and premium amortization.
Outlook, commentary and risks
- Management outlook: The company expected moderate but slowing U.S. economic growth and core inflation near the Federal Reserve’s 2% objective. It described continued focus on Agency RMBS and Agency CMBS, including specified pools with prepayment protection. No numerical company earnings or dividend guidance was provided.
- Funding and liquidity: Management believed available cash flow and borrowing capacity would meet anticipated short-term liquidity needs, but stated that long-term needs depend on obtaining additional debt financing. Most repurchase agreements are short-term and subject to refinancing, collateral haircuts and margin calls. The company cautioned that it cannot assure sufficient liquidity to meet future margin calls.
- Interest-rate, spread and prepayment exposure: About 92% of investments were fixed-rate. Under the company’s static-portfolio sensitivity analysis, a 100-basis-point rate increase was estimated to reduce projected portfolio value 1.90% and increase projected net interest income 1.56%; a 100-basis-point decrease was estimated to increase portfolio value 0.85% but reduce projected net interest income 7.92%. Management cautioned that assumptions and actual outcomes may differ.
- Other risks: Credit and real-estate performance, counterparty defaults, collateral values, hedge effectiveness and LIBOR transition are material exposures. The company had material LIBOR-linked contracts and was assessing transition risks ahead of the expected phaseout or change in LIBOR after 2021.
- Commitments and contingencies: Unfunded commitments included $29.9 million for a loan participation and $6.4 million for unconsolidated ventures. No legal proceedings were reported as of quarter-end; the filing said there were no material changes to previously disclosed risk factors.
- Subsequent event: Effective October 1, 2019, a management-agreement amendment changed the fee calculation to use average month-end GAAP stockholders’ equity for the prior quarter, while retaining a 1.50% annual fee rate.
Important facts for investors to verify
- Whether reported GAAP profits and book-value gains are sustainable, given their dependence on volatile fair-value changes and offsetting hedge losses; compare these with non-GAAP core earnings.
- How short-term repurchase funding, higher leverage, collateral haircuts and margin calls affect liquidity, especially as $18.37 billion of borrowings were scheduled to mature within one year.
- Whether the higher asset yields and larger portfolio compensate for increased funding costs, lower net interest margin and faster prepayments.
- The effect of common-share issuance and dilution on per-share earnings, dividends and book value.
- Progress on the LIBOR transition, the Q4 settlement and financing of TBA securities, and the company’s ability to meet its remaining unfunded commitments.