Invesco Mortgage Capital Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. The company is an externally managed mortgage REIT investing in residential and commercial mortgage securities and loans. Figures below are unaudited.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net interest income | $79.2m | $92.8m | $156.3m | $192.1m |
| Net income (loss) attributable to common stockholders | ($11.6m) | $142.3m | ($167.8m) | $128.5m |
| Basic EPS | ($0.10) | $1.16 | ($1.49) | $1.04 |
| Common dividend declared per share | $0.40 | $0.45 | $0.80 | $0.90 |
Q2 average earning-asset yield was 3.07% versus 3.18% a year earlier; reported net interest margin was 1.90% versus 1.64%. The company’s non-GAAP effective margin, which adjusts for swap interest and other items, was 1.42% versus 1.11%. Six-month net cash from operations was $161.8m; investing activities provided $571.7m and financing activities used $642.6m. Cash and cash equivalents ended at $144.1m.
At June 30, total assets were $16.66bn and total equity was $2.23bn. Debt comprised $11.77bn of repurchase agreements, $1.65bn of secured loans and $395.8m carrying value of exchangeable notes. Total debt-to-equity was 6.2x; repurchase-agreement debt-to-equity was 5.8x. Book value per diluted common share was $17.08, down from $17.14 at year-end 2015. Mortgage-backed and credit risk transfer securities had a fair value of $15.63bn.
Changes and management commentary
- Reported earnings deteriorated sharply, chiefly reflecting derivative losses: $90.4m in Q2 2016 versus a $56.0m gain in Q2 2015; six-month derivative losses were $328.9m versus $66.7m. Management attributed the 2016 losses largely to falling interest rates and changes in swap values.
- Net interest income declined, while reported net interest margin improved. The company attributed lower income mainly to a smaller portfolio; improved reported margin reflected, in part, lower amortization of deferred swap losses.
- Comparisons are affected by the December 2015 deconsolidation of residential securitization trusts. Those trusts contributed $5.7m of net income in Q2 2015 and $11.0m in the first half of 2015; their loan income and related funding costs are absent from 2016 results.
- Management described the low-rate environment and continued central-bank bond buying as broadly supportive for Agency RMBS, while noting market volatility after the Brexit vote. It shifted investment toward 15-year fixed-rate Agency RMBS to reduce duration and book-value volatility, and reported that Agency RMBS represented 40% of equity at quarter-end.
- The company terminated $4.8bn notional of swaps in the first half, realizing $64.0m of losses; $6.65bn notional of swaps remained at quarter-end. Management said overall interest-rate risk did not change materially from the terminations.
Outlook, risks and unusual items
- No specific earnings or dividend guidance was provided. Management said it believed available cash flow and borrowing capacity could meet anticipated short-term needs, but noted that long-term liquidity depends on access to additional financing and that sufficient liquidity for margin calls cannot be assured.
- Repurchase financing is predominantly short term and subject to collateral valuation, haircuts and margin calls. Key exposures include interest rates, yield-curve movements, credit spreads, mortgage prepayments and extensions, asset values, financing availability, and derivatives and counterparty risk.
- The company recorded $7.2m of other-than-temporary impairment losses on mortgage interest-only securities in the first half. It reported no allowance for losses on its ten commercial mezzanine loans at June 30.
- The company corrected accounting for premiums and discounts on certain non-Agency RMBS and revised comparative 2015 statements. It judged prior-period errors immaterial individually, but said the cumulative correction was material to Q2 2016; 2015 comparative figures in this filing are revised.
- PwC identified an auditor-independence issue under the SEC Loan Rule involving lenders and certain Invesco-affiliated funds. The company intends to rely on SEC staff no-action relief that expires December 20, 2017; absent permanent relief or another resolution, replacement audit work and potential financing or securities-issuance impacts could arise.
- The company reported compliance with repurchase-agreement covenants, effective disclosure controls, no material change in internal control over financial reporting, and no legal proceedings at quarter-end. It stated that the FHFA rule restricting captive-insurer membership should not affect existing FHLBI advances.
Important facts for investors to verify
- How much of reported earnings volatility reflects hedge accounting and fair-value movements versus underlying portfolio income; compare GAAP results with the company’s non-GAAP core earnings.
- Whether liquidity, unpledged collateral and financing counterparties remain adequate under higher haircuts, spread widening or adverse margin calls.
- How the portfolio shift toward Agency RMBS, changes in swap coverage and mortgage prepayment assumptions affect book value and future net interest income.
- The effects of the revised non-Agency RMBS accounting estimates and the company’s impairment judgments on future reported results.
- Whether PwC’s independence matter receives permanent resolution before the temporary SEC relief expires, and whether any financing or filing consequences result.