Invesco Mortgage Capital Inc. — Q3 2018 Form 10-Q
Business context and reporting period. This externally managed mortgage REIT invests in residential and commercial mortgage-backed securities, credit risk transfer securities, and mortgage loans. The filing covers the quarter and nine months ended September 30, 2018; financial statements are unaudited.
Financial and operating performance
- Q3 results: Interest income was $162.1 million and interest expense was $91.3 million, producing net interest income of $70.8 million, down from $86.2 million a year earlier. Net loss attributable to common stockholders was $64.5 million, or $0.58 per basic and diluted share, versus net income of $49.1 million, or $0.44 basic EPS, in Q3 2017.
- Nine-month results: Interest income was $466.9 million, interest expense $237.2 million, and net interest income $229.7 million, compared with $392.1 million, $136.7 million, and $255.4 million, respectively, in 2017. Net income attributable to common stockholders was $57.0 million, or $0.51 per share, versus $183.1 million, or $1.64 basic EPS, in 2017.
- Margins: GAAP net interest rate margin was 1.24% for Q3 and 1.43% for the first nine months, versus 1.79% and 1.89% in the comparable 2017 periods. The company’s non-GAAP effective interest rate margin was 1.13% and 1.22%, respectively.
- Investment and hedge results: Net investment losses were $207.9 million in Q3 and $404.7 million for nine months, compared with losses of $11.9 million and $2.6 million in 2017. Net derivative gains were $87.7 million and $288.2 million, respectively. Q3 included $140.7 million of realized losses on investment sales; the company said it repositioned its Agency portfolio into newly issued 30-year Agency RMBS and Agency CMBS.
- Balance sheet and leverage: Total assets were $19.22 billion and total equity $2.49 billion at September 30. Repurchase agreements were $14.38 billion and secured loans $1.65 billion; exchangeable notes were fully retired at maturity in March 2018. GAAP debt-to-equity was 6.4x and repurchase-agreement debt-to-equity was 6.6x. Book value per diluted common share was $16.83, down 8.3% from $18.35 at year-end 2017.
- Liquidity and cash flow: Cash, cash equivalents and restricted cash totaled $108.5 million at quarter-end. For the nine months, operating activities provided $221.7 million, investing activities used $180.7 million, and financing activities used $21.5 million. The filing states management believes available cash flow and borrowing capacity are sufficient for anticipated short-term liquidity needs, while noting liquidity cannot be assured under all conditions.
- Dividends: The company declared a common dividend of $0.42 per share for Q3. Nine-month cash dividends and distributions paid were $175.8 million.
Material changes versus the prior comparable period
- Higher average asset yields and earning assets lifted interest income, but the cost of funds rose faster: Q3 cost of funds increased to 2.29% from 1.43%, and nine-month cost to 2.02% from 1.26%. Management attributed the margin pressure mainly to Federal Reserve rate increases, higher borrowing rates, and increased average borrowings.
- Investment losses rose sharply, while derivative gains partly offset them. The company attributed the investment losses to sales and fair-value declines; it noted rising rates had reduced mortgage-backed securities valuations.
- The portfolio mix shifted toward Agency assets: Agency RMBS and CMBS increased to 51% of equity from 45% at year-end 2017. Thirty-year fixed-rate Agency RMBS represented about 57% of the investment portfolio, versus 42% at year-end.
- Borrowings increased to $16.03 billion from $15.87 billion at year-end, while short-term repurchase agreement weighted-average rates rose to 2.52% from 1.82%. The company retired its $143.4 million remaining exchangeable notes during the period.
Outlook, risks, contingencies and unusual items
- Outlook: No specific earnings or book-value guidance was provided. Management expected moderate U.S. economic growth and continued monetary tightening, while anticipating continued interest-rate volatility. It described Agency RMBS prospects as mixed and cited supportive fundamentals and demand for non-Agency CMBS and GSE CRT during the quarter.
- Interest-rate exposure: The filing’s sensitivity analysis estimates that an instantaneous 100-basis-point rate increase would reduce projected net interest income by 16.8% and portfolio value by 1.29%. A 100-basis-point decrease was estimated to reduce net interest income by 2.96% and increase portfolio value by 0.10%. These are model-based estimates with stated assumptions and limitations.
- Funding and liquidity risks: Most repurchase funding is short term and subject to refinancing, collateral valuation, haircuts and margin calls. Falling collateral values or wider credit spreads could require cash or additional collateral; the company cautioned it cannot assure sufficient liquidity to meet all margin calls.
- Other material risks: Risks include prepayment and extension behavior, credit losses, spread changes, counterparty defaults, derivative effectiveness, and real-estate values. A newly disclosed risk concerns TBA dollar rolls: negative carry, inability to roll, or margin calls could harm results or require cash settlement. The filing also notes uncertainty about TBA income treatment under REIT tests.
- Commitments and contingencies: Unfunded commitments included $10.1 million to affiliated-manager-sponsored ventures and $29.9 million on a loan participation. No commercial-loan loss allowance was recorded. The company reported no legal proceedings, no defaults upon senior securities, and no material change to previously disclosed risk factors other than the TBA risk.
- Unusual accounting/market items: Unrealized losses on mortgage-backed and credit risk transfer securities totaled $386.2 million at quarter-end; management said these were not considered credit-related for the relevant securities. Approximately 61% of the portfolio was accounted for under the fair-value option, compared with 36% at year-end 2017, increasing the share of valuation changes recognized in earnings.
Important facts for investors to verify
- How much of reported earnings and book-value movement reflects realized sales, fair-value marks, and hedge results, and how those results compare with management’s non-GAAP core earnings.
- Whether asset yields can keep pace with funding costs as rates rise, including the impact of short-term repo refinancing and hedges.
- Current unencumbered liquidity, margin-call capacity, financing haircuts, and the concentration and renewal profile of repo counterparties.
- The credit quality, geographic concentration, valuation assumptions, and performance of non-Agency holdings, GSE CRTs, and the loan participation; also monitor the $29.9 million unfunded commitment.
- The sustainability of the common dividend relative to recurring earnings, cash needs, and REIT distribution requirements.