Invesco Mortgage Capital Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Invesco Mortgage Capital is an externally managed mortgage REIT investing in residential and commercial mortgage-backed securities, loans and related assets. Amounts below are in U.S. dollars; financial statement figures are unaudited.
Financial performance and position
| Metric | Q3 2020 / September 30, 2020 | Comparable period / prior year-end |
|---|---|---|
| Interest income | $27.4 million | $196.3 million in Q3 2019 |
| Net interest income | $28.9 million | $73.0 million in Q3 2019 |
| Net income attributable to common stockholders; diluted EPS | $96.9 million; $0.53 | $77.9 million; $0.57 in Q3 2019 |
| Nine-month net loss; loss attributable to common stockholders; diluted EPS | $(1,797.1) million; $(1,830.4) million; $(10.87) | Net income of $246.1 million; common-stockholder income of $212.8 million; diluted EPS $1.65 in 2019 |
| Q3 / nine-month net interest rate margin | 2.79% / 2.46% | 1.20% / 1.20% in 2019 |
| Total assets; stockholders’ equity | $6,476.0 million; $1,211.1 million | $22,346.5 million; $2,931.9 million at December 31, 2019 |
| Book value per common share | $3.47 | $16.29 at December 31, 2019; down 79% |
| Cash and cash equivalents; restricted cash | $258.9 million; $166.2 million | Combined cash, cash equivalents and restricted cash: $425.1 million |
| Borrowings | $5,243.3 million in repurchase agreements; no secured loans | $19,182.3 million total borrowings at December 31, 2019 |
| Leverage | 4.3x debt-to-equity; 5.1x economic debt-to-equity, including TBAs | 6.5x at December 31, 2019 |
| Nine-month operating cash flow | $143.7 million | $217.9 million in 2019 |
Material changes and unusual items
- COVID-19 market disruption and sharp spread widening led to extraordinary margin calls in March. The company reported that it could not meet margin calls or comply with certain financing covenants; some repo counterparties seized and sold pledged securities. It repaid repo agreements that may have been in default by May 7 and fully repaid $1.65 billion of FHLBI secured loans during the first nine months.
- The company sold a substantial portion of its MBS and GSE CRT portfolio to raise liquidity and reduce leverage. The portfolio fell from $21.8 billion at year-end 2019 to $6.0 billion at September 30, 2020. It resumed purchases of Agency RMBS and began investing in TBAs in July. At quarter-end, Agency RMBS were about 80% of the investment portfolio including TBAs; TBAs represented about 13%.
- Nine-month investment losses were $996.7 million, including $358.9 million of net realized losses on sales and $537.4 million of net unrealized losses on securities accounted for under the fair value option. Derivative losses were $908.2 million, including a $904.7 million realized loss on interest-rate swaps terminated in the first half. The company recorded $94.1 million of impairment on securities it intended, or was more likely than not required, to sell before recovering cost.
- Q3 results included a $15.8 million net gain on extinguishment of debt, reflecting a one-time settlement with a counterparty, and $65.1 million of net investment gains. Q3 reported interest expense was negative $1.4 million, largely because $3.2 million of deferred hedge gains reduced reported expense; this is not the same as having no borrowing cost.
- Q3 net interest income fell year over year as the average earning-asset balance declined to $4.2 billion from $21.0 billion. Management cautioned that 2020 average assets and yields are not indicative of future interest-earning capacity following the portfolio restructuring.
Liquidity, outlook and risks
- At September 30, repo borrowings had a 0.23% weighted-average rate and 14-day weighted-average remaining maturity. The average Agency RMBS repo haircut was 5.0%. Short maturities require frequent refinancing and expose the company to funding, valuation and margin-call risk.
- Management stated that available cash flow and borrowing capacity should meet anticipated short-term liquidity needs, including investment activity, expenses and distributions. Long-term liquidity depends on obtaining additional debt financing; access to new financing is not assured. The company reported $514.0 million of unencumbered investments and $258.9 million of unrestricted cash.
- Management expected challenging and uncertain markets to persist amid the pandemic, renewed case growth and uncertainty over further stimulus. Risks include further spread widening, counterparty actions and higher haircuts, credit deterioration or defaults in residential and commercial mortgage assets, volatile prepayments, interest-rate and basis risk, and uncertainty in fair-value estimates.
- Commercial property risks were particularly notable for lodging and retail. The company also highlighted LIBOR transition risk: assets, liabilities and hedges may transition at different times or to different reference rates, complicating hedging and valuation.
- No quantitative earnings or dividend guidance was provided. Common dividends declared were $0.50 per share for Q1, paid partly in shares, $0.02 for Q2 and $0.05 for Q3. Preferred dividends were current. The company noted that future common dividends are at the board’s discretion and depend on earnings, liquidity and market conditions. REIT rules generally require distributions of at least 90% of taxable income.
- Undrawn capital and purchase commitments to affiliated-manager-sponsored ventures were $6.7 million. Management said disclosure controls were effective; no material legal proceedings were reported.
Important facts for investors to verify
- Whether repo counterparties renew or expand short-term financing, and how margin calls, haircuts and collateral valuations evolve.
- Whether reported liquidity, unencumbered assets and access to longer-term financing are adequate under renewed market stress.
- How the reconstructed Agency RMBS and TBA portfolio performs, including prepayment exposure, hedging effectiveness and leverage.
- The basis and sensitivity of investment fair values, realized and unrealized losses, and any further credit impairments as pandemic-related borrower and property risks develop.
- Whether cash generation and REIT taxable income support future common dividends, particularly given the large reduction in book value and the possibility of stock-paid distributions.
- The status of LIBOR-linked contracts and plans to manage mismatches during transition to alternative reference rates.