Invesco Mortgage Capital Inc. — Q1 2014 Form 10-Q
Business context and reporting period. The externally managed mortgage REIT invests in Agency and non-Agency residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS), and residential and commercial mortgage loans. This unaudited filing covers the three months ended March 31, 2014; comparisons are with Q1 2013 unless stated otherwise. The company’s objective is to generate risk-adjusted returns primarily through dividends.
Key financial results and position
Unless otherwise noted, amounts are in U.S. dollars.
| Metric | Q1 2014 / March 31, 2014 | Comparable period / December 31, 2013 |
|---|---|---|
| Interest income | $171.1 million | $160.5 million |
| Interest expense | $68.6 million | $67.6 million |
| Net interest income | $102.4 million; GAAP net interest margin 1.92% | $92.9 million; 1.64% |
| Effective net interest income and margin (non-GAAP) | $72.3 million; 1.21% | $92.9 million; 1.64% |
| Net income (loss) attributable to common shareholders | $(74.4) million; $(0.60) per diluted share | $84.0 million; $0.64 per diluted share |
| Core earnings (non-GAAP) | $56.9 million; $0.46 per share | $79.3 million; $0.62 per share |
| Common dividend declared per share | $0.50 | $0.65 |
| Total assets | $20.49 billion | $20.35 billion |
| Total liabilities / total equity | $18.04 billion / $2.45 billion | $17.95 billion / $2.40 billion |
| Cash and cash equivalents | $188.4 million | $210.6 million |
| Total debt-to-equity ratio | 7.0x | 6.4x at March 31, 2013 |
| Book value per common share, fully diluted | $18.53 | $17.97 at December 31, 2013 |
At March 31, the investment portfolio included $17.54 billion of MBS at fair value, $2.07 billion of residential loans and $92.7 million of commercial loans. Debt included $14.85 billion of repurchase agreements, $1.87 billion of asset-backed securities (ABS) and $400 million of exchangeable senior notes. Repo borrowings carried a weighted-average rate of 0.84% across borrowings shown in the filing; the $400 million notes bear 5.00% interest.
Cash flow was $89.0 million provided by operating activities, $380.7 million provided by investing activities and $492.0 million used in financing activities. Cash declined by $22.2 million during the quarter.
Material changes versus the prior comparable period
- GAAP results shifted from common-shareholder income of $84.0 million to a loss of $74.4 million. The largest reported factor was a $151.3 million loss on interest-rate derivative instruments, compared with a $2.0 million loss in Q1 2013.
- Net interest income increased by $9.5 million, while portfolio yield rose to 3.52% from 3.21%. However, effective cost of funds rose to 2.31% from 1.57%, and effective net interest income declined to $72.3 million from $92.9 million.
- Management attributed the GAAP loss principally to the change in swap accounting, losses on expired swaptions, securities sold at a loss, and higher borrowing costs. Management’s non-GAAP core earnings exclude certain market-value and realized items and should not be treated as GAAP income or cash available for dividends.
- The company voluntarily discontinued cash-flow hedge accounting for interest-rate swaps effective December 31, 2013. Beginning January 1, 2014, swap fair-value changes and net swap interest are recorded in earnings rather than being accounted for as they were under the prior hedge treatment. The company reported $90.2 million of unrealized swap losses and $21.3 million of amortization of deferred swap losses in Q1.
- Portfolio strategy continued shifting away from fixed-rate Agency RMBS toward credit assets and adjustable-rate securities. Management reported lower repo leverage and increased hedging; swap notional was $12.8 billion versus $10.7 billion at March 31, 2013. The company also repurchased 1.44 million common shares for $21.1 million.
- Other comprehensive income was $202.5 million, largely reflecting improved MBS valuations; book value per share rose from year-end. No other-than-temporary impairment charges were recorded in Q1.
Outlook, management commentary, risks and unusual items
- Management said Q1 market conditions were favorable: interest rates and implied volatility declined, credit spreads tightened, and Agency MBS prices benefited. It expects to continue pursuing commercial mortgage loans, subordinate interests in residential loan securitizations and GSE credit-risk-transfer securities during 2014. No numerical earnings or dividend guidance was provided.
- Management stated it believed available cash flow and borrowing capacity would meet anticipated short-term needs, including investments, debt service, dividends and margin requirements. Long-term liquidity depends on obtaining additional debt financing or raising capital. The filing cautions that sufficient liquidity to meet margin calls cannot be assured.
- Repurchase agreements are short-term and subject to renewal, collateral valuation and margin calls. The weighted-average collateral haircuts were approximately 4.55% for Agency RMBS, 19.71% for non-Agency RMBS and 18.74% for CMBS. Repo counterparties held about $16.5 billion of company MBS as collateral against $14.9 billion of repo debt.
- Interest-rate, spread, prepayment, extension, credit, property-value and counterparty risks may affect income, asset values, hedging effectiveness and liquidity. The filing’s modeled sensitivity showed that a 100-basis-point rate increase would reduce projected portfolio value by 1.18% but increase projected net interest income by 14.60%; a 100-basis-point decrease would increase portfolio value by 0.14% and reduce projected net interest income by 60.67%. These are model estimates under stated assumptions, not forecasts.
- California represented 49.9% of residential loan principal and 45.3% of non-Agency RMBS collateral. Credit losses, geographic concentration and reliance on management’s valuation and cash-flow assumptions remain relevant risks.
- The company had $533.0 million of investment-related payables and $303.6 million of investment-related receivables at quarter-end, primarily associated with unsettled securities trades. It had $12.2 million of unfunded commercial-loan commitments and $5.4 million remaining under its commitment to affiliated investment funds.
- Derivative agreements include financial-condition and equity-related default provisions. The company reported compliance with those provisions and repo covenants at March 31, 2014. Management also identified dependence on its external manager and the possibility of adverse effects if the management agreement ends without a suitable replacement.
Important facts for investors to verify
- How reported GAAP earnings and core earnings reconcile, and how the new swap accounting treatment affects future earnings volatility and comparability.
- Whether effective funding costs, hedging costs and net interest margins support the common dividend over time; the declared Q1 common dividend was $0.50 per share.
- Repo renewal terms, collateral haircuts, counterparty concentration and liquidity available to meet potential margin calls.
- Asset performance and valuation assumptions for non-Agency RMBS, CMBS and residential and commercial loans, including geographic concentrations and future credit-loss provisions.
- Execution and funding of the unsettled securitization-related trades and other commitments, and the implications of leverage rising to 7.0x total debt-to-equity.