Invesco Mortgage Capital Inc. — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012. The company invests in and finances residential and commercial mortgage-backed securities (MBS) and mortgage loans; it is externally managed and operates as a REIT.
Financial results and position
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Interest income | $139.0m | $109.0m | $281.0m | $177.5m |
| Interest expense | $56.7m | $34.2m | $112.0m | $49.8m |
| Net interest income | $82.3m | $74.8m | $169.0m | $127.7m |
| Net income attributable to common shareholders | $78.8m | $73.0m | $161.9m | $125.2m |
| EPS | $0.68 | $0.99 | $1.40 | $2.00 |
| Dividend declared per common share | $0.65 | $0.97 | $1.30 | $1.97 |
- Q2 net interest margin was 1.82%, versus 2.75%; six-month margin was 1.92%, versus 2.89%. Portfolio yield declined while hedged funding costs increased.
- At June 30, total assets were $16.36bn, including $16.05bn of MBS; total liabilities were $14.21bn and total equity was $2.15bn. Repurchase-agreement borrowings were $13.54bn.
- Debt-to-equity was 6.30x at quarter-end. Repurchase agreements had a 0.65% weighted-average rate and 21-day weighted-average remaining maturity. MBS collateral was 110% of repo borrowings.
- Cash was $168.6m and restricted cash $14.7m. Six-month operating cash flow was $203.7m; investing activities used $1.43bn and financing activities provided $1.19bn. Cash ended the period at $168.6m.
- Book value per diluted share was $18.40, compared with $18.42 at March 31 and $16.41 at December 31, 2011. Six-month other comprehensive income was $220.2m, primarily reflecting fair-value changes in securities and hedges.
- Portfolio fair value increased to $16.05bn from $14.21bn at year-end 2011. At June 30, equity allocation was 52.6% Agency RMBS, 27.1% non-Agency RMBS, 17.7% CMBS and 2.6% unconsolidated ventures.
Changes versus comparable periods
- Common-shareholder net income rose year over year, but EPS fell as the weighted-average basic share count increased to 115.4m from 73.5m for Q2 and 115.4m from 62.7m for the six-month period.
- Growth in the investment portfolio increased interest income and net interest income, but rising funding and hedging costs and a lower-yielding asset mix compressed margins. Annualized return on average equity was 14.70% in Q2 versus 18.99%; six-month return was 15.41% versus 18.80%.
- Portfolio growth included a larger Agency RMBS position. Average portfolio yield for Q2 fell to 3.51% from 4.29%; average hedged cost of funds rose to 1.69% from 1.54%.
- Net unrealized losses on MBS and derivatives were $6.0m in Q2 2012, versus $156.2m in Q2 2011; six-month other comprehensive income was $220.2m, versus a $116.0m loss.
Outlook, risks and unusual items
- No specific earnings or dividend guidance was provided. Management stated it expects cash flow from operations and available borrowing capacity to cover anticipated short-term needs, while longer-term liquidity depends on obtaining additional debt financing.
- The company declared a $0.65 common dividend, paid July 27, 2012. It subsequently issued 5.4m shares of 7.75% Series A preferred stock for approximately $130.7m net proceeds; an additional 200,000 shares were issued under the over-allotment option for about $5.0m net.
- Interest-rate, prepayment, extension, credit-spread, collateral-value, counterparty and financing risks are material. Repo borrowings are short-term and subject to refinancing, collateral haircuts and margin calls. Management noted that hedges may not fully offset rate exposure and can themselves generate fair-value losses.
- The filing’s modeled instantaneous rate scenarios show projected net interest income changing by +11.71% for a 100-basis-point rise and −47.77% for a 100-basis-point fall; projected portfolio value changes by −1.66% and +0.28%, respectively. These are model estimates, not forecasts.
- At quarter-end, interest-rate swap liabilities were $446.6m and the company had posted $478.6m of Agency RMBS collateral against swaps. The company was compliant with applicable financing and derivative covenants.
- Management reported no other-than-temporary impairment for the three- or six-month periods. Gross unrealized losses on Agency-CMO, non-Agency RMBS and CMBS totaled $96.5m; management attributed them to non-credit factors and continues quarterly impairment reviews.
- The company had a $17.1m remaining capital commitment to the Invesco IMRF Fund and AIV. Its PPIP financing was repaid in March 2012, and it was awaiting final distribution from the fund. No legal proceedings or material changes to previously disclosed risk factors were reported.
- Management stated it believed the company met REIT income, asset, ownership and distribution requirements at June 30, 2012. Failure to maintain REIT or Investment Company Act status could materially affect operations, distributions or permitted leverage.
Investor verification priorities
- Assess whether margin compression, lower portfolio yields and higher hedging costs affect recurring earnings and the sustainability of the common dividend.
- Review short repo maturities, lender concentration, collateral haircuts, available liquidity and the potential size of margin calls under adverse market conditions.
- Examine the valuation and credit exposure of non-Agency RMBS and CMBS, especially the geographic concentration of non-Agency collateral in California (49.8%).
- Reconcile reported net income with EPS and per-share book value, including share issuance, dividends and non-cash fair-value movements.
- Verify the effect of the Series A preferred issuance on capital structure, funding costs and cash available to common shareholders.