Invesco Mortgage Capital Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Financial statements are unaudited. The company is an externally managed mortgage REIT investing in residential and commercial mortgage securities and loans.
Key financial results
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Interest income | $140.4 million | $118.1 million | $392.1 million | $364.1 million |
| Net interest income | $86.2 million | $84.9 million | $255.4 million | $241.1 million |
| Net income (loss) | $63.5 million | $136.7 million | $210.7 million | $(21.6) million |
| Net income (loss) attributable to common stockholders | $49.1 million | $129.2 million | $183.1 million | $(38.6) million |
| Diluted EPS | $0.43 | $1.05 | $1.59 | $(0.34) |
| Common dividend declared per share | $0.41 | $0.40 | $1.21 | $1.20 |
| Net interest rate margin | 1.79% | 2.00% | 1.89% | 1.91% |
Higher interest income reflected larger average earning assets and lower premium amortization, but higher borrowing costs compressed reported margins. Q3 common earnings fell substantially year over year as derivative and credit-derivative results were weaker and preferred dividends increased. For the nine months, the much improved GAAP result versus 2016 primarily reflected a smaller derivative loss.
- Cash flow, nine months: $225.9 million provided by operations, $3.12 billion used in investing, and $2.81 billion provided by financing. Cash and cash equivalents ended at $73.5 million, down from $161.8 million at year-end 2016.
- Balance sheet, September 30: Total assets were $18.80 billion and total equity was $2.66 billion. Mortgage-backed and credit risk transfer securities were $18.26 billion at fair value.
- Debt and leverage: Repurchase agreements were $14.09 billion, secured loans $1.65 billion, and exchangeable notes $157.4 million carrying value. Total debt-to-equity was 6.0x, versus 5.8x at year-end 2016; repurchase-agreement debt-to-equity was 6.3x. Repo weighted-average interest rate was 1.57%, with 19 days’ average remaining maturity.
- Liquidity and collateral: Securities pledged under repo and secured loans totaled $17.35 billion. Repo collateral coverage was 110%. The company said it believes current operating cash flow and borrowing capacity can meet anticipated short-term needs, while cautioning that it cannot assure sufficient liquidity for margin calls.
- Book value: Book value per diluted common share was $18.34, up 4.9% from $17.48 at December 31, 2016, which management attributed primarily to tighter spreads and higher portfolio valuations.
Material changes and capital allocation
- The investment portfolio grew to $18.56 billion from $15.29 billion at year-end 2016. Agency RMBS represented 41% of equity; commercial credit 38%; residential credit 21%.
- The company purchased $4.9 billion of 30-year fixed-rate Agency RMBS and $665.1 million of CMBS during the nine months. Thirty-year Agency holdings rose to about 40% of the portfolio from 20% at year-end 2016; CMBS allocation also increased. Non-Agency RMBS fair value declined to $1.42 billion from $2.00 billion.
- In August, the company issued 11.5 million Series C preferred shares at $25 each, raising $287.5 million before $9.4 million of issuance costs. It used capital alongside increased borrowing and portfolio cash flows to fund investments.
- The company repurchased $242.2 million par value of exchangeable notes for $247.5 million during the nine months, recording a $6.6 million extinguishment loss. Remaining notes mature in March 2018.
Outlook, risks and unusual items
- No specific earnings, book-value, or dividend guidance was provided. Management intends to continue regular quarterly common and preferred distributions and believes its proposed operations should satisfy REIT requirements; distributions remain subject to operating and debt-service needs.
- Management described Q3 markets as lower-volatility with generally tighter credit, while noting uncertainty around geopolitics, Brexit, U.S. policy, economic data, and the effects of Federal Reserve balance-sheet reduction. It expected prepayment speeds to moderate seasonally, but this is not a quantified company forecast.
- Key exposures include rising rates, spread widening, prepayment and extension risk, mortgage credit and property values, short-term repo refinancing, lender haircuts and margin calls, counterparty risk, and dependence on financing availability. Interest-rate sensitivity estimates showed projected net interest income down 21.95% and portfolio value down 1.62% under an instantaneous +100 basis-point parallel shift; these are model-based estimates, not forecasts.
- Unrealized losses on securities were $114.4 million at quarter-end; the company said it did not consider them credit-related, while continuing quarterly impairment assessments. Q3 included $5.0 million of impairment losses on RMBS interest-only securities.
- Preferred Series C issuance increased preferred-dividend claims on earnings. A cumulative out-of-period equity rebalancing adjustment increased additional paid-in capital and reduced non-controlling interest by $3.6 million, with no income-statement impact.
- PwC identified an auditor-independence issue under the SEC Loan Rule related to lenders and certain Invesco-affiliated funds. The SEC Staff extended no-action relief indefinitely in September 2017 under the specified circumstances. If future circumstances fall outside that relief, alternative audit arrangements and related costs could be required, with possible effects on securities issuance eligibility and financing covenants.
- The company reported no material changes to previously disclosed risk factors apart from the auditor-independence matter; no legal proceedings were reported. Disclosure controls were deemed effective, with no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether portfolio growth and the shift toward 30-year Agency RMBS and CMBS sustain returns as funding costs and repo rates rise.
- How margin-call liquidity, repo haircuts, short maturities, collateral coverage, and lender concentration evolve; cash alone was $73.5 million at quarter-end.
- Whether derivative hedges adequately offset rate and spread exposure, including the significant modeled downside to net interest income under a +100 bp shock.
- The sustainability of common distributions relative to recurring earnings, REIT taxable income, and the enlarged preferred-dividend burden.
- Repayment or refinancing of the remaining exchangeable notes due March 2018 and continued access to financing.
- Ongoing auditor independence under the terms of SEC no-action relief and any effect on filings, capital-raising eligibility, or lender covenants.