Invesco Mortgage Capital Inc. — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Invesco Mortgage Capital is an externally managed mortgage REIT investing in residential and commercial mortgage-related assets. The filing describes severe market disruption associated with COVID-19, including sharply wider spreads, margin calls and forced portfolio reductions.
Key financial results and position
| Metric | Q2 2020 | Six months ended June 30, 2020 |
|---|---|---|
| Interest income | $30.2 million | $216.9 million |
| Net interest income | $29.7 million | $130.7 million |
| Net income (loss) | $(288.8) million | $(1.905) billion |
| Net loss attributable to common stockholders | $(299.9) million; $(1.80) per diluted share | $(1.927) billion; $(11.91) per diluted share |
| Net interest rate margin | 6.15% | 2.42% |
| Operating cash flow | $130.6 million for the six months |
Q2 2019 comparisons were net income of $18.3 million, common earnings of $7.2 million ($0.06 per share), and net interest income of $73.0 million. For the first half of 2019, net income was $157.1 million, common earnings were $134.9 million ($1.08 per share), and net interest income was $147.0 million. The higher reported 2020 Q2 margin reflects, in part, the sharply reduced portfolio and lower funding costs; management cautions that the period’s average earning assets and yields are not indicative of future interest income.
Balance sheet at June 30: Total assets were $1.95 billion and stockholders’ equity was $1.16 billion, down from $22.35 billion and $2.93 billion, respectively, at December 31, 2019. Mortgage-backed and credit risk transfer securities were $1.58 billion, versus $21.77 billion year-end. Cash and cash equivalents were $270.2 million; cash, cash equivalents and restricted cash totaled $271.6 million. Book value per common share was $3.17, down 80.5% from $16.29.
Debt and liquidity: At June 30, the company had no repurchase-agreement borrowings and $740 million of FHLBI secured loans, with a 0.62% weighted-average rate and repayment due by December 2020. It repaid all repurchase agreements by May 7 after repaying $17.5 billion during the first half, and repaid $910 million of secured loans. In July, it repaid a further $435 million, leaving $305 million outstanding as of July 31. First-half cash flows were $18.0 billion provided by investing activities, primarily from asset sales, and $18.2 billion used in financing activities, primarily to repay borrowings and pay dividends.
Material changes and unusual items
- To address margin calls and reduce leverage, the company sold MBS and GSE CRTs for $23.1 billion in cash proceeds during the first half. Its investment portfolio contracted from $21.9 billion at year-end to $1.6 billion at June 30.
- Reported first-half investment losses were $1.062 billion, including $409.0 million of net realized losses on investment sales and $85.1 million of impairment charges on securities the company intended or was more likely than not required to sell before recovery of amortized cost.
- First-half derivative losses were $911.1 million, primarily from terminating interest-rate swaps amid falling rates. The company had no interest-rate swaps outstanding at June 30; it resumed hedging after restarting Agency purchases in July.
- The company was unable to meet margin calls and was not in compliance with certain borrowing covenants at March 31. Some counterparties seized and sold collateral. The FHLBI modified secured-loan terms following covenant noncompliance; the modification was treated as a troubled debt restructuring.
- Common dividends changed materially: the $0.50-per-share first-quarter dividend was paid largely in shares on June 30 (16.3 million shares plus about $8.2 million cash). The declared Q2 common dividend was $0.02 per share, paid in cash in July. Preferred dividends were current.
- A counterparty claim of $22.9 million was recorded as a liability at June 30. A July mutual release settled the claim and is expected to produce a $15.9 million gain in Q3 2020.
Outlook, commentary and principal risks
Management said mortgage-REIT market conditions were expected to remain challenging amid uncertainty about the duration and effects of COVID-19. It reported a cautious outlook despite a broad market rebound in Q2, citing ongoing uncertainty, commercial real estate stress and possible renewed shutdowns. It expects short-term liquidity needs to be met based on the portfolio, available borrowing capacity and anticipated asset-sale proceeds, but says longer-term capital needs depend on obtaining additional debt financing. There is no specific earnings or dividend guidance in the provided filing text.
As of July 31, management reported a $3.3 billion investment portfolio, approximately $230.3 million cash, $2.1 billion of repo borrowings and $305 million of secured loans. The portfolio was 68% Agency RMBS, 30% commercial credit and 2% residential credit; approximately $473 million was unencumbered. Management said it was evaluating additional financing sources, with no assurance it could obtain them.
- Key exposures include renewed margin calls, limited or more costly financing, forced asset sales, market liquidity and valuation uncertainty, interest-rate and spread movements, and the absence of swaps at quarter-end.
- COVID-19 may increase borrower delinquency, forbearance and default, particularly in commercial property sectors such as lodging and retail, and may weaken collateral values and investment performance.
- Other risks include prepayment and extension uncertainty, LIBOR transition and mismatches among asset, funding and hedge reference rates, and the company’s ability to maintain REIT and Investment Company Act status.
- The company reported no legal proceedings as of June 30. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether asset-sale proceeds and the remaining collateral are sufficient to repay the $305 million secured-loan balance and support liquidity without further distressed sales.
- Current repo financing terms, borrowing capacity, margin requirements and unencumbered assets following the July return to Agency investing and repo financing.
- Updated portfolio values, CMBS underlying credit performance, and the effects of COVID-19 on delinquencies, tenant payments and expected credit losses.
- Whether common dividends can be sustained and the implications of stock-paid distributions, dilution and taxable income exceeding cash received.
- Recognition of the $15.9 million Q3 debt-extinguishment gain and any further settlements, claims or losses associated with the March financing disruption.