Invesco Mortgage Capital Inc. — 2011 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2011; quarterly results include the three months ended December 31, 2011. Invesco Mortgage Capital is an externally managed mortgage REIT investing in Agency and non-Agency residential mortgage-backed securities, commercial mortgage-backed securities, and mortgage-related investments. Its objective is to provide risk-adjusted returns primarily through dividends. Amounts below are U.S. dollars; financial statement amounts are converted from thousands to millions or billions.
Financial performance and position
| Metric | 2011 | 2010 |
|---|---|---|
| Interest income | $453.4 million | $134.2 million |
| Interest expense | $155.2 million | $29.6 million |
| Net interest income | $298.1 million | $104.7 million |
| Net income attributable to common shareholders | $281.9 million | $98.4 million |
| Basic and diluted earnings per share | $3.27 | $3.78 |
| Dividends declared per common share | $3.42 | $3.49 |
| Net interest margin | 2.48% | 3.63% |
| Annualized return on average equity | 17.64% | 17.58% |
- Average investment portfolio yield fell to 4.12% from 5.03%; average hedged funding cost rose to 1.64% from 1.40%. Management attributed the narrower margin chiefly to higher hedging costs and a larger allocation to lower-yielding Agency RMBS.
- At year-end, total assets were $14.77 billion, including $14.21 billion of mortgage-backed securities; repurchase-agreement borrowings were $12.25 billion. Total equity was $1.92 billion. Period-end debt-to-equity increased to 6.4x from 4.1x; the company generally targeted 3x–7x.
- Book value per diluted share declined to $16.41 from $20.49, primarily reflecting valuation changes in investments and interest-rate hedges.
- Operating cash flow was $305.4 million; investing activities used $9.15 billion and financing activities provided $8.98 billion. Year-end cash was $197.2 million, with an additional $74.5 million of restricted cash.
- The 2011 quarterly dividend declarations declined from $1.00 per share in Q1 to $0.65 in Q4. Q4 net income attributable to common shareholders was $75.6 million, or $0.66 per share, versus $81.1 million, or $0.79 per share, in Q3.
Material changes versus the prior comparable period
- Three 2011 follow-on offerings raised approximately $1.2 billion net, and the dividend reinvestment/share-purchase plan raised approximately $85.8 million. The resulting equity and additional repo financing drove substantial portfolio growth: year-end MBS increased to $14.21 billion from $5.58 billion.
- Annual net income and net interest income rose substantially with the larger portfolio, but earnings per share declined, reflecting the expanded share count and lower portfolio yield. Net interest margin compressed by 1.15 percentage points.
- Other comprehensive loss was $423.9 million in 2011, compared with $17.8 million of other comprehensive income in 2010. The company said the loss was primarily attributable to cash-flow hedges and reported that book value is sensitive to market-value movements.
- Portfolio equity allocation shifted toward Agency RMBS: 55.1% at year-end versus 48.2% in 2010. Non-Agency RMBS declined to 24.5% from 37.1%; CMBS rose to 16.8% from 9.4%.
- The common stock traded between $12.55 and $16.23 in Q4 2011, compared with a $20.83–$23.60 range in Q4 2010. A board-approved authorization to repurchase up to 7 million shares had not been used by year-end.
Outlook, risks, contingencies, and unusual items
- Management stated it believed operating cash flow and available borrowing capacity would cover anticipated short-term liquidity needs, including investments, debt service, dividends, and expenses. Long-term liquidity depends on obtaining additional debt financing. This is not a guarantee of future liquidity.
- The filing gives no formal earnings or dividend guidance. Management intended to continue quarterly distributions, subject to earnings, liquidity, financing obligations, REIT requirements, and board discretion; it did not establish a minimum dividend.
- Financing is highly leveraged and short-term: all $12.25 billion of reported repo obligations were classified as due within one year in the contractual-obligations table. Falling collateral values, wider spreads, higher haircuts, or lender withdrawals could trigger margin calls, forced asset sales, or refinancing pressure. Year-end weighted average repo haircuts were 4.77% for Agency, 19.15% for non-Agency, and 19.72% for CMBS.
- Interest-rate swaps hedged approximately $6.9 billion of repo borrowing. Derivative liabilities were $396.8 million at year-end; the company had posted approximately $19.7 million in cash and $447.6 million in Agency RMBS as swap collateral. It estimated $121.6 million would be reclassified from accumulated other comprehensive income as an increase to interest expense over the next 12 months.
- The company’s only credit default swap had a $112.1 million remaining notional amount and exposed it to payments above a specified 25% loss threshold on a non-Agency RMBS pool. It had posted $17.3 million of collateral and reported no payments under the contract through year-end.
- Management cited interest-rate and prepayment volatility, credit losses, real estate weakness, foreclosure delays, counterparty and liquidity risk, and uncertainty around regulation and the government-sponsored housing entities. The Federal Reserve’s Operation Twist could flatten the yield curve, increase prepayments, and narrow margins. The filing identified no material legal proceedings as of year-end.
- The company reported that it met REIT and Investment Company Act exemption requirements for 2011. Failure to maintain either status could materially affect taxes, permitted activities, leverage, and distributions. The external manager receives a fee based on equity and has investment-allocation and other potential conflicts; the 2011 management fee was $26.3 million.
- Grant Thornton issued unqualified opinions on the financial statements and internal control over financial reporting. Management also concluded disclosure controls and internal controls were effective as of December 31, 2011.
Important facts for investors to verify
- How current repo financing, lender concentration, collateral haircuts, and available unencumbered liquidity compare with the $12.25 billion year-end borrowing balance and the company’s margin-call exposure.
- Whether portfolio marks and reported book value reflect realizable values, particularly for non-Agency RMBS, CMBS, and hedges; review the $423.9 million other comprehensive loss and the assumptions used in fair-value estimates.
- Whether net interest margin, hedging costs, and prepayment speeds support earnings and dividends after the 2011 portfolio expansion; reconcile annual EPS and declared dividends with actual cash generation.
- The potential effect of hedge collateral and future reclassification of $121.6 million into interest expense, along with swap-counterparty default or termination provisions.
- Whether the manager’s fee and allocation practices, the remaining $20.3 million investment commitment, and REIT and Investment Company Act compliance remain consistent with shareholder interests and liquidity needs.