Invesco Mortgage Capital Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The company is an externally managed mortgage REIT investing primarily in residential and commercial mortgage-backed securities and related assets. Its stated objective is to provide returns primarily through dividends and secondarily through capital appreciation.
Financial and operating results
- Revenue and earnings: Interest income was $643.0 million, up from $545.1 million in 2017. Net interest income fell to $304.1 million from $348.5 million. GAAP net loss was $70.5 million; after preferred dividends, the loss attributable to common stockholders was $115.2 million, or $1.03 per diluted share. In 2017, common stockholders had net income of $320.5 million, or $2.75 per diluted share.
- Non-GAAP core earnings: $193.0 million, or $1.73 per common share, versus $192.6 million, or $1.73 per share, in 2017. The company cautions that core earnings are not a substitute for GAAP results or operating cash flow.
- Margins: Net interest rate margin declined to 1.39% from 1.87%; effective interest rate margin, a non-GAAP measure, declined to 1.23% from 1.32%. The company attributed pressure mainly to higher short-term borrowing costs.
- Cash flow: Operating activities provided $304.3 million, investing activities provided $621.6 million, and financing activities used $879.2 million. Cash and cash equivalents were $135.6 million at year-end.
- Assets, equity and debt: Total assets were $17.81 billion and total equity was $2.29 billion. Repurchase agreements were $13.60 billion and secured loans were $1.65 billion; the exchangeable senior notes were fully retired at maturity in March 2018. Total debt-to-equity was 6.7x, compared with 6.0x in 2017; repurchase-agreement debt-to-equity was 7.0x, compared with 6.1x.
- Book value: Book value per diluted common share fell 16.8% to $15.27 from $18.35. Management cited higher rates, wider Agency MBS spreads and underperformance in Agency MBS, partly offset by interest-rate hedges.
- Dividends: Common dividends declared for 2018 totaled $1.68 per share ($0.42 quarterly). Preferred dividends are cumulative and have stated annual rates of 7.75% for Series A and B and 7.50% for Series C.
Material changes and unusual items
- Net loss on investments was $327.7 million, compared with a $19.7 million loss in 2017. The 2018 amount included a $218.1 million realized net loss on sales; the company sold approximately $5.0 billion of MBS while repositioning its portfolio. It stated these realized sale losses did not further reduce book value because the securities were already carried at fair value.
- The company’s 2018 portfolio purchases were concentrated in newly issued 30-year fixed-rate Agency RMBS, Agency CMBS and selected credit securities. 30-year fixed-rate Agency RMBS increased to 56% of the investment portfolio from 42%; Agency CMBS became a new portfolio investment. Agency RMBS and Agency CMBS represented 49% of equity allocation at year-end, versus 45% in 2017.
- Interest expense rose to $338.9 million from $196.6 million, driven mainly by higher repurchase-agreement borrowing costs and increased average borrowings. Average cost of funds increased to 2.16% from 1.33%.
- Net derivative instrument loss was $5.3 million for the year. This included an $86.3 million realized loss on Treasury futures, partly offset by interest-rate swap gains. Derivative results were volatile: fourth-quarter derivative loss was $293.5 million, while fourth-quarter investment results included a $77.0 million gain.
- Fourth-quarter net loss attributable to common stockholders was $172.2 million, or $1.54 per share. The company also reported losses attributable to common stockholders in the first and third quarters and profits in the second quarter.
- In February 2019, after year-end, the company completed a public offering of 16.1 million common shares at $15.73 per share, generating approximately $249.7 million net proceeds.
Outlook, risks and contingencies
- Management expected moderate but slowing U.S. economic growth and core inflation near the Federal Reserve’s 2% objective. It identified slowing growth, uncertain Federal Reserve policy, trade disputes, central-bank actions, Brexit-related uncertainty and changing financing-market regulation as concerns. No quantified earnings or dividend guidance was provided.
- Management said current cash flow and borrowing capacity were expected to meet anticipated short-term needs, including investments, debt service and distributions. Long-term liquidity depends on obtaining additional debt financing; the filing gives no assurance that financing will remain available on acceptable terms.
- Key risks include high leverage and short-term repo refinancing, margin calls, collateral-value declines, rising funding costs, interest-rate and spread volatility, prepayment and extension risk, credit losses, counterparty exposure and valuation uncertainty. The company reported $13.6 billion of repo borrowings, generally short-dated, and $135.6 million of cash and cash equivalents at year-end.
- The company had $10.0 million of unfunded commitments to affiliated-manager-sponsored ventures and a $20.0 million unfunded commitment for its loan participation. It reported compliance with financing covenants at year-end and no provision for commercial-loan losses.
- The filing discusses LIBOR transition risk: LIBOR may be phased out or changed after 2021, and the company has material contracts indexed to USD-LIBOR. Maintaining REIT qualification and applicable Investment Company Act exclusions also constrains investment and financing choices.
- PwC disclosed an auditor-independence issue involving lender relationships with certain funds in the Invesco complex. The company stated it relied on SEC staff no-action relief, which was extended indefinitely; circumstances outside that relief could require other action.
- The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting. Management also concluded disclosure controls and internal control over financial reporting were effective as of year-end. The filing reported no material legal proceedings at December 31, 2018.
Most important facts for investors to verify
- Whether the decline in book value and 2018 investment losses persist, and how much subsequent portfolio performance reflects market changes versus realized sales.
- Whether net interest margin stabilizes as funding costs, asset yields and interest-rate hedges reset.
- Liquidity available for repo margin calls and refinancing, including the maturity profile of short-term borrowings and collateral haircuts.
- The sustainability of common dividends relative to taxable income, cash generation, preferred dividends and leverage; the filing does not establish a minimum common dividend.
- The effect of the February 2019 common-stock offering on book value per share, leverage and future earnings per share.
- Progress on LIBOR transition and any developments affecting the auditor-independence relief or REIT and Investment Company Act status.