Invesco Mortgage Capital Inc. — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; balance-sheet comparisons are with December 31, 2012. Income and cash-flow comparisons are with Q1 2012. Unless stated otherwise, dollar amounts below are in millions.
Business context
The company is an externally managed mortgage REIT investing in Agency and non-Agency residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS), and mortgage loans. It primarily finances its securities portfolio through short-term repurchase agreements and seeks shareholder returns mainly through dividends.
Financial performance and condition
| Metric | Q1 2013 / March 31, 2013 | Comparable period / prior date |
|---|---|---|
| Interest income | $160.5 | $142.0 in Q1 2012 |
| Interest expense | $67.6 | $55.3 in Q1 2012 |
| Net interest income | $92.9 | $86.7 in Q1 2012 |
| Net income | $87.7 | $84.1 in Q1 2012 |
| Net income attributable to common shareholders | $84.0; basic EPS $0.65, diluted EPS $0.64 | $83.1; basic and diluted EPS $0.72 |
| Common dividend declared per share | $0.65 | $0.65 in Q1 2012 |
| Cash from operating activities | $121.6 | $101.3 in Q1 2012 |
| Cash and cash equivalents | $274.5 | $286.5 at December 31, 2012 |
| Total assets | $22,104 | $18,915 at December 31, 2012 |
| Total equity | $2,915 | $2,590 at December 31, 2012 |
| MBS at fair value | $21,248 | $18,471 at December 31, 2012 |
| Repurchase agreements | $17,873 | $15,720 at December 31, 2012 |
- Average portfolio yield fell to 3.21% from 3.76% in Q1 2012; average cost of funds was 1.57% versus 1.70%, and net interest margin narrowed to 1.64% from 2.06%.
- Average debt-to-equity was 6.36x versus 6.23x; period-end debt-to-equity was 6.40x versus 6.04x. Repurchase agreements had a 57-day average remaining maturity overall; Agency repo maturities averaged 15 days.
- Book value per common share was $20.42, down from $20.83 at year-end. Other comprehensive loss was $51.7, versus income of $226.2 in Q1 2012, mainly reflecting market-value changes in securities and hedges.
- Investing activities used $3,349 of cash, mainly for $4,671 of MBS purchases and $405 of residential-loan purchases. Financing activities provided $3,216, including equity issuance, repo borrowings, $400 of exchangeable notes, and $374 of asset-backed securities.
Material changes and unusual items
- The company issued $400 of 5.00% exchangeable senior notes due 2018, receiving $387.9 net proceeds. The notes are exchangeable at an initial price of approximately $23.76 per share.
- In March, the company consolidated a securitization trust holding 488 residential loans with $389.9 principal. The trust had $405.5 of loans and $374.2 of asset-backed securities outstanding at quarter-end; the financing is non-recourse to the company. No loan-loss allowance was recorded, and the disclosed loan pool had no delinquencies.
- A January common-stock offering generated approximately $359 net proceeds; the dividend reinvestment and stock purchase plan generated about $22 during the quarter. Shares outstanding increased materially.
- Net interest income increased as the portfolio expanded, but common EPS declined, reflecting preferred dividends and a larger share count. Management attributed lower portfolio yield to the low-rate environment and Federal Reserve quantitative easing.
- The filing’s statements of operations report total expenses of $11.987, while the listed expense components total $11.897; MD&A reports $11.897. The net-income arithmetic also aligns with $11.897. This apparent filing inconsistency merits verification.
Outlook, risks and contingencies
- No specific earnings or dividend guidance is provided. Management said current operating cash flow and available borrowing capacity were expected to cover anticipated short-term liquidity needs, including investments, borrowings, and distributions; long-term liquidity depends on continued access to financing.
- Management expected Federal Reserve asset purchases to keep Agency MBS yields low and refinancing volumes elevated, which could pressure returns. It also stated that the existing HARP program was not expected to have a material effect on results.
- Key risks include interest-rate and spread movements, prepayments and extension risk, credit losses, repo refinancing and counterparty risk, margin calls, and the potential loss of financing access. Repo lenders can demand additional collateral as asset values decline. Repo collateral coverage was 111% at quarter-end.
- Interest-rate swaps with $10.65 billion notional were used to hedge borrowing exposure. Derivative liabilities were $420.4; the company had posted $475.9 of Agency RMBS as swap collateral. It reported compliance with applicable repo and derivative financial covenants at March 31.
- Notes are full-recourse obligations and include cross-default provisions. If exchanged, the company expects to settle with common shares, potentially diluting shareholders. The company also had $17.1 of remaining capital commitments to managed investment vehicles.
- Management estimated that an instantaneous 100-basis-point rate increase would reduce portfolio value 1.81% and increase projected net interest income 8.84%; a 100-basis-point decrease was estimated to increase portfolio value 0.53% and reduce projected net interest income 51.34%. These are model-based estimates, not forecasts.
- The company reported no legal proceedings, no material changes to previously disclosed risk factors other than the new notes-related risks, effective disclosure controls, and no material change in internal control over financial reporting.
Important facts for investors to verify
- Reconcile the $11.987 versus $11.897 total-expense figures and confirm the correct reported amount.
- Review the sensitivity of earnings, book value, and collateral needs to rate and spread movements, given high leverage and short repo maturities.
- Assess the notes’ recourse, cross-default terms, maturity funding plan, and potential dilution at the exchange price.
- Monitor the new residential-loan securitization’s credit performance, geographic concentration, and non-recourse structure.
- Confirm that dividend capacity remains supported by taxable income, liquidity, and financing access; the filing states that REIT distributions are based on taxable income, not GAAP net income.