Invesco Mortgage Capital Inc. — Q2 2019 Form 10-Q
Reporting period: Unaudited quarter and six months ended June 30, 2019; comparisons are to the corresponding 2018 periods unless noted. The company is an externally managed mortgage REIT investing primarily in residential and commercial mortgage-backed securities and related assets.
Financial performance and position
- Q2 earnings: Net interest income was $73.0 million, down from $73.7 million. Net income was $18.3 million versus $92.3 million; income attributable to common stockholders was $7.2 million, or $0.06 per diluted share, versus $80.0 million, or $0.72. Core earnings, a company-defined non-GAAP measure, were $59.1 million, or $0.46 per share, versus $46.1 million, or $0.41.
- First-half earnings: Net interest income was $147.0 million versus $158.8 million. Common-stockholder income was $134.9 million, or $1.08 per diluted share, versus $121.5 million, or $1.08. Core earnings were $116.0 million, or $0.93 per share, versus $96.5 million, or $0.86.
- Interest and margins: Q2 interest income rose to $202.2 million from $151.6 million, while interest expense increased to $129.2 million from $77.9 million. Q2 net interest margin declined to 1.16% from 1.38%; average earning-asset yield rose to 3.89%, but average cost of funds rose to 2.73%. The first-half net interest margin was 1.21%, down from 1.51%.
- Volatile investment and hedge results: Q2 investment gains were $302.2 million, including $304.7 million of net unrealized gains on securities accounted for under the fair value option; derivative losses were $344.7 million. For the first half, investment gains were $570.6 million and derivative losses were $546.2 million. Management attributed the unrealized security gains to tighter spreads and valuation gains in specified Agency pools, and hedge losses primarily to falling rates.
- Balance sheet at June 30: Total assets were $22.04 billion, including $21.54 billion of mortgage-backed and credit-risk-transfer securities. Total liabilities were $19.37 billion and equity was $2.67 billion. Borrowings totaled $18.73 billion: $17.08 billion in repurchase agreements and $1.65 billion in secured loans. GAAP debt-to-equity was 7.0x; the company’s non-GAAP repurchase-agreement debt-to-equity measure was 7.4x.
- Liquidity and cash flow: Cash and cash equivalents were $99.6 million and restricted cash was $55.3 million. For the first half, operating activities provided $157.0 million, investing activities used $3.75 billion, and financing activities provided $3.61 billion. Repurchase-agreement borrowings are generally short term; $17.34 billion of total borrowings was scheduled to mature within one year.
- Book value and distributions: Book value per common share increased 6.2% from December 31, 2018, to $16.21. The declared quarterly common dividend was $0.45 per share; preferred dividends were also declared at stated series rates.
Material changes versus comparable periods
- Compared with Q2 2018, Q2 2019 common earnings and EPS fell sharply as large derivative losses more than offset securities gains; net interest income also edged lower. Core earnings per share increased, illustrating the effect of excluding specified market-value and derivative items.
- For the first half, common earnings rose despite lower net interest income, with much larger investment gains offset substantially by derivative losses. First-half core earnings also increased.
- The portfolio expanded: securities fair value rose to $21.54 billion from $17.40 billion at year-end 2018. Agency CMBS grew to $2.93 billion from $1.00 billion, while the company sold most of its ARM and hybrid ARM securities. Common shares outstanding increased to 128.8 million from 111.6 million, reflecting the February public offering and at-the-market issuance.
- Book value per common share rose from $15.27 at year-end. Management cited tighter interest-rate spreads across Agency and credit assets as a principal driver.
Outlook, management commentary and risks
- No specific earnings or return guidance was provided. Management said it believed operating cash flow and available borrowing capacity would meet anticipated short-term liquidity needs, but long-term requirements would depend on obtaining additional debt financing.
- Management described the U.S. economy as growing moderately, with subdued inflation and expectations of increased mortgage prepayments as refinancing incentives rose. It saw Agency RMBS prospects as mixed, citing prepayment and Federal Reserve reinvestment risks alongside wider spreads and attractive funding costs.
- Key exposures include short-term repo refinancing, collateral haircuts and margin calls; rate, spread, prepayment and extension risk; credit and real-estate-market risk; derivatives and counterparty risk; and dependence on continued access to financing. The filing warns that insufficient liquidity could force asset sales in unfavorable markets.
- LIBOR was expected to be phased out or changed after 2021. The company had material LIBOR-linked contracts and was evaluating the transition; proposed SOFR changes for centrally cleared swaps were preliminary.
- Unfunded commitments were $27.1 million for a loan participation and $6.5 million for investments in unconsolidated ventures. Management reported compliance with repo covenants. No material change to previously reported risk factors, legal proceedings, or subsequent-event disclosures was reported.
Important facts for investors to verify
- How much of reported earnings and book-value movement reflects recurring interest income versus fair-value changes and derivative settlements; compare GAAP results with management’s non-GAAP core measure.
- Whether repo financing can be renewed on acceptable terms and whether available cash and unpledged collateral can cover margin calls, particularly given the large amount of near-term maturities.
- How rising CPRs and refinancing activity affect premium amortization, asset yields and the value of specified mortgage pools.
- The sustainability of common and preferred dividends relative to taxable income, cash generation, financing needs and leverage.
- Progress on LIBOR-to-SOFR contract transition and the resulting effects on funding, hedging, valuation and liquidity.