Invesco Mortgage Capital Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016. The company is an externally managed mortgage REIT investing in residential and commercial mortgage-backed securities, credit risk transfer securities and mortgage loans. Financial statements are unaudited.
Financial performance and position
| Metric | Q1 2016 | Q1 2015 or prior date |
|---|---|---|
| Interest income | $126.0 million | $167.8 million |
| Interest expense | $50.1 million | $72.3 million |
| Net interest income | $75.9 million | $95.5 million |
| Net loss attributable to common stockholders | $157.3 million; $(1.39) per share | $17.4 million; $(0.14) per share |
| Core earnings (non-GAAP) | $49.9 million; $0.44 per share | $62.0 million; $0.50 per share |
| Net interest margin / effective margin (non-GAAP) | 1.78% / 1.46% | 1.69% / 1.22% |
| Operating cash flow | $78.9 million | $87.4 million |
| Cash and cash equivalents at period-end | $51.3 million | $53.2 million at Dec. 31, 2015 |
| Total assets / total equity at period-end | $15.9 billion / $2.16 billion | $16.8 billion / $2.27 billion at Dec. 31, 2015 |
| Debt at carrying value | $13.23 billion | $14.17 billion at Dec. 31, 2015 |
| Book value per diluted common share | $16.53 | $17.14 at Dec. 31, 2015 |
Q1 investing activities provided $1.06 billion, principally from securities sales and principal repayments. Financing activities used $1.14 billion, including net repurchase-agreement repayments, dividends and $25.0 million of share repurchases. Total debt-to-equity was 6.1x, down from 6.3x at year-end; repurchase-agreement debt-to-equity was 5.8x.
Material changes versus comparable periods
- Net loss widened substantially, mainly because net derivative losses increased to $238.5 million from $122.7 million. The company attributed the losses largely to falling interest rates and the resulting losses on interest-rate swap hedges, including $166.5 million of unrealized derivative losses.
- Interest income and net interest income decreased year over year, while net interest margin increased to 1.78% from 1.69%. Effective margin, a non-GAAP measure, rose to 1.46% from 1.22%.
- Year-over-year results are not fully comparable: 2015 included residential securitization trusts, which were deconsolidated in December 2015. Their 2015 contribution included $29.4 million of residential-loan interest income and $21.9 million of asset-backed-securities interest expense.
- The investment portfolio’s fair value declined to $15.13 billion from $16.07 billion at year-end. Accumulated other comprehensive income increased to $426.5 million; Q1 other comprehensive income was $125.0 million, partially offsetting the net loss in comprehensive results.
- Common dividends declared were $0.40 per share, compared with $0.45 in Q1 2015. The company repurchased 2.06 million shares at an average $12.12 per share for $25.0 million.
Outlook, risks and unusual items
- No specific earnings or dividend guidance was provided. Management said it expected short-term liquidity needs to be met from operating cash flow and available borrowing capacity, but noted that long-term funding depends on obtaining additional debt financing.
- Management described a cautious Federal Reserve outlook and a generally supportive low-rate environment for Agency RMBS, while noting that non-Agency securities had faced spread volatility. It said it intended to maintain a balanced allocation among commercial credit, Agency RMBS and residential credit.
- Interest-rate, spread, prepayment and extension risks are material. The company relies substantially on short-term repurchase financing, which is subject to collateral revaluation, margin calls and refinancing risk. At March 31, repurchase agreements totaled $11.19 billion, with a 111% collateral ratio and a 16-day weighted-average remaining maturity for Agency RMBS financing overall reflected in the borrowing table by asset type.
- Management’s interest-rate sensitivity analysis estimated that a parallel 100-basis-point increase would reduce projected net interest income by 14.83% and portfolio value by 0.86%; a 100-basis-point decrease was estimated to reduce projected net interest income by 20.12% and portfolio value by 0.26%. The filing cautions that these are model-based estimates and actual results may differ.
- The company recorded $5.7 million of other-than-temporary credit impairment on certain RMBS interest-only securities. It reported no allowance for losses on its commercial loans, which were not considered impaired.
- Unfunded commitments included $20.7 million to unconsolidated ventures and $27.1 million on commercial loans. A new $25 million mezzanine-loan commitment was partially funded in April.
- Auditor-independence uncertainty: PwC advised that it was discussing with SEC staff the interpretation of auditor-independence rules concerning certain lender relationships with preferred-stock holders or record holders in funds managed by the Manager. PwC and the Audit Committee stated their view that independence was not impaired, but the outcome was uncertain. The filing warns that an adverse SEC determination could affect the filing’s compliance, require another firm to review the interim statements, affect shelf-registration eligibility, or affect financing covenants.
- The company said it was in compliance with repurchase and derivative financial covenants, believed it continued to qualify as a REIT, and reported effective disclosure controls. No material legal proceedings or defaults were reported.
Important facts for investors to verify
- Follow the SEC staff’s resolution of the PwC independence matter and assess any consequences for the filing, shelf registration or financing covenants.
- Reconcile GAAP losses with non-GAAP core earnings and evaluate the impact of derivatives, hedge positioning and interest-rate movements on book value.
- Assess liquidity beyond reported cash, including available borrowing capacity, collateral haircuts, margin-call exposure and short-term repo maturities.
- Review the sustainability of common dividends against taxable income, cash generation, preferred dividends and REIT distribution requirements.
- Track the funding, performance and credit quality of commercial loans and unconsolidated ventures, including the substantial increase in unfunded commercial-loan commitments.