Invesco Mortgage Capital Inc. — 2015 Form 10-K
Business context and reporting period. This is the audited annual report for the fiscal year ended December 31, 2015, not a standalone quarterly filing. Invesco Mortgage Capital is an externally managed mortgage REIT investing in Agency and non-Agency residential mortgage-backed securities, GSE credit-risk-transfer securities, commercial mortgage-backed securities, and residential and commercial loans. Its stated objective is to deliver returns primarily through dividends and secondarily through capital appreciation.
Key financial results
| Metric | FY 2015 | FY 2014 |
|---|---|---|
| Interest income | $644.5 million | $676.6 million |
| Interest expense | $278.0 million | $281.9 million |
| Net interest income | $366.5 million | $394.7 million |
| Net income (loss) attributable to common stockholders | $81.1 million | $(245.5) million |
| Basic and diluted EPS attributable to common stockholders | $0.67 | $(1.99) |
| Core earnings per common share (non-GAAP) | $1.73 | $1.89 |
| Operating cash flow | $358.6 million | $379.7 million |
| Cash and cash equivalents at year-end | $53.2 million | $164.1 million |
GAAP net income improved mainly because derivative losses and losses on investment sales were lower than in 2014. Derivatives still generated a $219.0 million net loss in 2015. Net interest income declined 7% year over year, reflecting lower portfolio yield and a shift in financing mix. Average portfolio yield was 3.22% versus 3.41%; reported net interest margin was 1.66% versus 1.80%. Management’s non-GAAP effective interest-rate margin was 1.12% versus 1.23%; these non-GAAP measures are not substitutes for GAAP results or cash available for distributions.
Balance sheet and funding: Total assets were $16.8 billion, down from $21.2 billion, while total equity was $2.27 billion, down from $2.64 billion. Mortgage-backed and credit-risk-transfer securities were $16.1 billion. Debt included $12.1 billion of repurchase agreements, $1.65 billion of secured loans, and $400 million of 5.00% exchangeable senior notes due 2018. Total debt-to-equity was 6.3x, down from 6.9x; repurchase-agreement debt-to-equity was 5.7x, up from 5.4x. The weighted-average remaining maturity of borrowings was 389 days, compared with 335 days.
Operating activities generated $358.6 million of cash; investing activities generated $1.24 billion, largely as principal repayments and securities-sale proceeds exceeded purchases; financing activities used $1.71 billion. The company reported that it believed liquidity and borrowing capacity were sufficient for anticipated short-term needs, while noting that longer-term needs depend on obtaining additional debt financing. Repurchase agreements generally mature in one to twelve months and expose the company to refinancing and margin-call risk.
Portfolio, dividends, and material changes
- At year-end, equity allocation was 37% Agency RMBS, 33% commercial credit, and 30% residential credit. The investment portfolio totaled $16.27 billion, down from $20.76 billion, with the comparison affected substantially by deconsolidation of residential loan securitizations.
- On December 9, 2015, the company sold certain interests in its residential securitizations for $69.0 million, lost primary-beneficiary status, and deconsolidated the trusts. This removed $3.20 billion of assets and $2.75 billion of liabilities from the balance sheet and resulted in a $19.6 million loss. Management cited capital reallocation and reduced accounting and audit costs as objectives.
- Book value per diluted common share was $17.14, compared with $18.82 at year-end 2014. Management attributed the decline primarily to portfolio valuation changes recorded in accumulated other comprehensive income.
- Common dividends declared totaled $1.70 per share for 2015, down from $1.95 in 2014; quarterly payments declined from $0.45 to $0.40 during 2015. Preferred dividends are cumulative. The board authorized an additional 15 million shares for the repurchase program on February 18, 2016, subsequent to year-end.
- The company repurchased 9.54 million common shares during 2015 for $125.6 million, at an average $13.17 per share. It had authority to repurchase 5.30 million additional shares at year-end, before the subsequent authorization increase.
Outlook, risks, and unusual items
Management expected moderate U.S. economic growth and inflation below the Federal Reserve’s 2% objective, and described range-bound interest rates and continued Federal Reserve reinvestment in Agency MBS as potentially supportive of Agency RMBS. It also noted wider structured-credit spreads, rising repurchase financing rates late in 2015, and uncertainty around global growth and markets. The filing provides no specific earnings, dividend, or portfolio guidance.
- Interest-rate and spread exposure: A modeled parallel 100-basis-point rate increase was estimated to reduce projected net interest income by 12.30% and portfolio value by 0.88%; a 50-basis-point increase was estimated to reduce them by 2.31% and 0.30%, respectively. Management cautioned that assumptions and actual outcomes may differ materially.
- Leverage and liquidity: Falling collateral values, higher haircuts, lender actions, or counterparty defaults could trigger margin calls or forced asset sales. Cash at year-end was $53.2 million. Three repurchase counterparties held collateral exceeding related borrowings by more than $113.3 million, or 5% of stockholders’ equity.
- Portfolio risks: Credit losses, prepayment and extension behavior, valuation uncertainty, illiquidity, and geographic concentration could affect earnings, book value, and distributions. California represented 42.7% of non-Agency RMBS collateral and 21.9% of GSE CRT collateral; California and New York were the largest listed CMBS state exposures.
- Restatement and controls: The company restated 2013–2014 annual statements and interim periods through Q1 2015 after errors in accounting for GSE CRTs and Agency MBS interest-only securities. It reported a material weakness in controls, stated that remediation was completed by December 31, 2015, and concluded disclosure controls and internal control over financial reporting were effective at year-end. The auditor issued unqualified opinions on the financial statements and internal controls.
- Other: The company reported no legal proceedings as of year-end. It remained subject to REIT qualification and Investment Company Act exclusion requirements. A new FHFA rule affecting captive insurers was not expected by management to affect existing FHLB advances; the subsidiary could remain a member for five years under the rule.
Most important facts for investors to verify
- Review the restatement details and accounting treatment of GSE CRTs and Agency MBS interest-only securities, including the reported remediation of the material weakness.
- Reconcile GAAP earnings, the $219.0 million derivative loss, and non-GAAP core earnings; assess how derivative accounting affects period-to-period comparability.
- Assess the sustainability of the reduced common dividend against taxable income, operating cash flow, funding costs, and REIT distribution requirements.
- Review repurchase-agreement maturities, collateral haircuts, counterparty exposure, margin-call liquidity, and the 2018 exchangeable-note maturity.
- Evaluate the deconsolidation’s effects on reported assets, liabilities, leverage, earnings, and comparability with prior periods, as well as the company’s valuation and geographic concentration disclosures.