Invesco Mortgage Capital Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Unaudited consolidated results. The company is an externally managed mortgage REIT investing in mortgage-backed securities, mortgage loans and related assets; its stated objective is attractive risk-adjusted returns, primarily through dividends.
Key financial metrics
| Metric | Q3 2014 | Nine months 2014 | Comparison |
|---|---|---|---|
| Interest income | $169.4 million | $514.9 million | Q3: $171.3 million; nine months: $507.5 million in 2013 |
| Net interest income | $99.1 million | $306.6 million | Q3: $81.7 million; nine months: $270.9 million in 2013 |
| Net income (loss) | $34.4 million | $(130.5) million | 2013: $(6.0) million and $224.7 million, respectively |
| Net income (loss) attributable to common shareholders | $30.7 million; $0.25/share | $(137.8) million; $(1.12)/share | 2013: $(8.7) million; $(0.06)/share, and $214.2 million; $1.61/share, respectively |
| Common dividends declared | $0.50/share | $1.50/share | 2013: $0.50/share and $1.80/share, respectively |
| Operating cash flow | Not presented by quarter | $278.3 million | $381.2 million in 2013 |
Q3 net interest margin was 1.84% versus 1.38% in 2013; nine-month margin was 1.89% versus 1.53%. The company’s non-GAAP effective net interest margin, which incorporates swap interest, was 1.17% for Q3 and 1.20% for the nine months, compared with 1.38% and 1.53%, respectively, in 2013. Non-GAAP core earnings were $54.3 million ($0.44/share) in Q3 and $173.3 million ($1.41/share) for the nine months, versus $66.7 million ($0.49/share) and $226.5 million ($1.70/share) in 2013.
At September 30, 2014, total assets were $21.0 billion, including $17.3 billion of MBS and $3.1 billion of residential loans. Total liabilities were $18.3 billion; shareholders’ equity was $2.65 billion. Debt included $13.6 billion of repurchase agreements, $1.25 billion of secured advances, $2.75 billion of securitization ABS and $400 million of exchangeable notes. Cash and cash equivalents were $128.9 million. Total debt-to-equity was 6.7x; book value per common share was $19.16, versus $17.97 at December 31, 2013.
Nine-month cash flows were $278.3 million provided by operating activities, $704.8 million used in investing activities and $344.8 million provided by financing activities. Cash declined by $81.7 million from year-end 2013.
Material changes versus comparable periods
- Q3 common earnings improved from a loss to a profit, supported by higher net interest income and lower realized MBS sale losses than in Q3 2013. For the nine months, the company moved from common income to a loss, principally reflecting the accounting and earnings impact of de-designating interest-rate swaps, realized losses on expired swaptions and higher realized MBS sale losses.
- Effective January 1, 2014, swap fair-value changes and net swap interest were recorded in earnings rather than under the prior cash-flow-hedge presentation. This contributed to a $322.8 million net derivative loss for the nine months; it also makes reported GAAP income more volatile. The filing reports $64.1 million of deferred swap losses amortized into interest expense during the nine months.
- Repurchase agreements declined from $15.45 billion at December 31, 2013 to $13.57 billion at September 30, 2014. The company said it reduced leverage and substituted some repurchase financing with long-term FHLB advances. It reported repurchase debt at 5.2x equity versus 5.8x one year earlier.
- The portfolio mix shifted toward credit and loan assets: MBS fair value was broadly flat year to date, while residential loans rose to $3.10 billion from $1.81 billion and commercial loans to $144.7 million from $64.6 million. The company consolidated four new residential securitizations during the nine months and expected two more to close in Q4.
- The company issued $149.9 million net of costs of Series B preferred stock in September. The shares carry a 7.75% cumulative dividend through December 2024, then a floating rate of three-month LIBOR plus 5.18%. It repurchased 1.44 million common shares for $21.1 million during the nine months.
Outlook, management commentary and risks
- No specific earnings or dividend guidance was provided. Management said it expected short-term liquidity to be adequate for anticipated needs, while long-term liquidity depends on obtaining additional debt financing. Management intended to continue regular quarterly distributions, subject to operating and debt-service needs and REIT requirements.
- Management described low interest-rate volatility and a flattening yield curve in Q3, but said wider required spreads on CMBS and GSE credit-risk-transfer securities pressured prices and modestly reduced book value during the quarter. It viewed wider spreads as potentially favorable for reinvestment over time and said it had reduced interest-rate sensitivity, while remaining exposed to credit spreads.
- Funding and liquidity are material risks: most repurchase funding is short-term and can be repriced or recalled; falling collateral values or higher haircuts can trigger margin calls. Management stated there is no assurance liquidity will be sufficient to meet such calls. FHLB advances were $1.25 billion with no additional borrowing availability at quarter-end.
- Other key risks include interest-rate and prepayment/extension risk, credit losses, counterparty default, collateral valuation, derivative exposure and REIT qualification. Residential loans were geographically concentrated, with 51.8% of principal in California. The company also noted that regulatory changes affecting mortgage finance, banks and FHLB membership could affect investment opportunities or financing.
- The company reported no material legal proceedings and stated disclosure controls were effective as of September 30, 2014. Management did not expect the cited newly issued accounting standards to materially affect its financial statements.
Important facts for investors to verify
- Reconcile GAAP losses with non-GAAP core earnings and effective interest measures, particularly the treatment and timing of swap-related losses and interest.
- Review the maturity, renewal terms, collateral haircuts and counterparty concentration of repurchase funding, and the company’s unencumbered liquidity available for margin calls.
- Assess whether portfolio growth in residential loans, CMBS and GSE CRT changes credit, geographic and valuation risk; verify securitization performance and loan delinquency trends.
- Confirm the sustainability of common and preferred dividends against taxable income, cash generation, funding costs and REIT distribution requirements.
- Track the effect of interest rates and credit spreads on book value, collateral values, hedge effectiveness and financing access; the filing’s sensitivity analysis shows materially different projected effects for rate increases versus decreases.