Invesco Mortgage Capital Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Unaudited consolidated results. Amounts below are U.S. dollars; financial amounts are in millions unless stated otherwise.
Business context
The externally managed REIT invests in, finances and manages residential and commercial mortgage-backed securities, credit risk transfer securities and mortgage loans. Its stated objective is to provide returns primarily through dividends and secondarily through capital appreciation.
Financial performance and position
- Q3 earnings: Interest income was $118.1 million and net interest income was $84.9 million. Net income attributable to the company was $134.9 million; common-stockholder income was $129.2 million, or $1.16 basic and $1.05 diluted per share.
- Nine-month earnings: Interest income was $364.1 million and net interest income was $241.1 million. The company recorded a $21.4 million net loss attributable to the company and a $38.6 million loss attributable to common stockholders, or $0.34 per share.
- Net interest margin: 2.00% for Q3 versus 1.65% in Q3 2015; 1.91% for the nine months versus 1.68% in 2015. Average earning-asset yield declined to 2.94% in Q3 from 3.18% and to 3.10% for nine months from 3.24%.
- Cash flow: Operating activities provided $251.5 million in the first nine months, compared with $276.0 million in 2015. Investing activities provided $130.7 million and financing activities used $388.1 million. Cash and cash equivalents ended at $47.3 million, down from $53.2 million at year-end 2015.
- Balance sheet and leverage: Total assets were $16.9 billion and total equity $2.34 billion. Borrowings totaled $14.11 billion, including $12.06 billion of repurchase agreements, $1.65 billion of secured loans and $400 million face amount of exchangeable notes. Total debt-to-equity was 6.0x, down from 6.3x at year-end; repurchase-agreement debt-to-equity was 5.7x, unchanged.
- Portfolio and book value: Mortgage-backed and credit risk transfer securities had a fair value of $16.07 billion. Book value per diluted common share was $18.08 versus $17.14 at year-end, a 5.5% increase, primarily attributed to tighter credit spreads and higher portfolio valuations.
- Dividends and capital: Common dividends were $0.40 per share for Q3, unchanged year over year; nine-month declared dividends were $1.20 per share versus $1.30. The company repurchased 2.06 million shares for $25.0 million during the first nine months.
Changes versus comparable periods
- Q3 common-stockholder results swung from a $144.5 million loss in 2015 to $129.2 million income in 2016. The principal driver was the derivative result: a $35.4 million gain in Q3 2016 versus a $220.6 million loss in Q3 2015.
- Nine-month common-stockholder loss widened from $16.0 million to $38.6 million. Net interest income fell from $283.3 million to $241.1 million, partly offset by lower total expenses.
- Year-over-year comparisons are affected by the December 2015 deconsolidation of residential securitizations. The 2015 comparative periods included their loans, asset-backed debt and operating expenses; 2016 did not. Management cited this change and a smaller portfolio, following asset sales and share repurchases, as key reasons for lower interest income and net interest income.
- During Q3, the company recorded a $65.4 million unrealized gain on interest-rate swaps; for the nine months, derivative instruments produced a $293.5 million net loss. These fair-value results make GAAP earnings notably sensitive to market movements.
Outlook, risks and unusual items
- Outlook: No specific earnings, book-value or dividend guidance was provided. Management said it believed short-term liquidity and available borrowing capacity would cover anticipated needs, while longer-term requirements depend on obtaining additional debt financing. It expected interest rates to remain relatively low and described the environment as supportive for mortgage-backed securities investors.
- Portfolio strategy: Management increased Agency RMBS to 44% of equity and emphasized 15-year fixed-rate Agency RMBS to reduce interest-rate risk and book-value volatility. It described the allocation shift as reducing risk ahead of elections, Federal Reserve decisions and Brexit developments.
- Funding and liquidity risks: Most financing is short-term repo debt, with an average remaining maturity of 18 days. Falling collateral values or higher haircuts may trigger margin calls; the company cautioned it cannot assure sufficient liquidity in all circumstances. It reported compliance with repo covenants and no cash collateral required by repo counterparties at quarter-end.
- Market and credit risks: Interest-rate changes, spread widening, prepayment or extension behavior, mortgage credit losses, real-estate values and counterparty availability may affect income, asset values and liquidity. The filing’s modeled +100-basis-point rate shock indicated a 20.09% decline in projected net interest income and a 1.18% decline in projected portfolio value; actual outcomes may differ materially.
- Hedges and derivatives: Outstanding interest-rate swaps had $6.5 billion notional. The company terminated $5.0 billion notional during the nine months, realizing $69.1 million in losses. Derivative liabilities were $382.3 million; cash and Agency RMBS collateral posted against swaps totaled approximately $411.0 million.
- Contingencies and regulation: Undrawn commitments were $16.3 million to affiliated-manager-sponsored ventures and $11.8 million on commercial loans. Management said the FHFA rule restricting captive-insurer membership was not expected to affect existing FHLBI advances. No material legal proceedings were reported, and no material risk-factor changes were identified.
- Unusual accounting item: The company revised prior-period figures for errors in premium and discount accounting on certain non-Agency RMBS, which it deemed immaterial to previously issued statements. The revision changed nine-month 2015 common loss from $22.1 million to $16.0 million and EPS from a $0.18 loss to a $0.13 loss. A $2.3 million cumulative one-time management-fee adjustment was recorded in Q3 2016 related to the correction.
Key facts for investors to verify
- Reconcile GAAP earnings with core earnings, which were $0.41 per share in Q3 and $1.29 for nine months; core earnings are a non-GAAP measure and not a measure of cash available for dividends.
- Assess sensitivity to derivative fair-value swings, interest rates, credit spreads, prepayments and collateral-related margin calls, including the short maturity of repo funding.
- Evaluate the comparability impact of the December 2015 securitization deconsolidation and the prior-period accounting revision.
- Monitor whether the $0.40 quarterly common dividend is supported by future operating results, taxable income and liquidity needs.
- Review the assumptions behind reported portfolio valuations, credit-loss estimates and the modeled interest-rate sensitivity.