Invesco Mortgage Capital Inc. — 2012 Form 10-K
Business context and reporting period. This filing covers the fiscal year ended December 31, 2012; the filing also reports unaudited fourth-quarter results. 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 generate returns primarily through dividends. It relies largely on short-term repurchase-agreement financing and operates to maintain REIT status and an exemption from investment-company registration.
Financial performance and position
| Metric | 2012 | 2011 |
|---|---|---|
| Interest income | $566.8 million | $453.4 million |
| Interest expense | $237.4 million | $155.2 million |
| Net interest income | $329.4 million | $298.1 million |
| Net interest margin | 1.79% | 2.50% |
| Net income attributable to common shareholders | $334.5 million | $281.9 million |
| Diluted earnings per common share | $2.89 | $3.27 |
| Common dividends declared per share | $2.60 | $3.42 |
| Net cash provided by operating activities | $427.5 million | $305.4 million |
| Cash and cash equivalents at year-end | $286.5 million | $197.2 million |
| Total assets at year-end | $18.9 billion | $14.8 billion |
| Repurchase agreements at year-end | $15.7 billion | $12.3 billion |
| Total equity at year-end | $2.59 billion | $1.92 billion |
| Debt-to-equity ratio at year-end | 6.1x | 6.4x |
| Book value per common share, fully diluted | $20.83 | $16.41 |
Fourth quarter: Net income attributable to common shareholders was $89.5 million, or $0.77 per share, compared with $75.6 million, or $0.66 per share, in Q4 2011. Net interest income was $80.3 million versus $82.5 million. Interest income rose to $145.4 million from $137.5 million, while interest expense increased to $65.1 million from $55.0 million.
Investing activities used $3.68 billion of cash in 2012, primarily reflecting securities purchases; financing activities provided $3.34 billion. The annual average portfolio yield declined to 3.47% from 4.14%, while average hedged funding cost rose to 1.68% from 1.64%. Annualized return on average equity was 14.96%, down from 17.64%.
Material changes and capital
- The mortgage-backed securities portfolio grew to $18.47 billion from $14.21 billion. Equity allocation shifted toward non-Agency RMBS and CMBS: Agency RMBS represented 48.6% of equity, non-Agency RMBS 28.9%, and CMBS 21.1% at year-end 2012.
- Repurchase-agreement borrowings increased by $3.47 billion year over year. Their weighted-average rate was 0.78%, and average remaining maturity was 17 days at year-end. The portfolio’s average debt-to-equity ratio during 2012 was 6.3x.
- In July and August, the company issued 5.6 million shares of 7.75% Series A cumulative redeemable preferred stock, raising $135.4 million net of issuance costs. It also raised about $16.4 million net through its dividend reinvestment and share purchase plan.
- Unrealized gains on mortgage-backed securities and derivatives were $485.7 million for 2012, versus an unrealized loss of $423.9 million in 2011. Year-end accumulated other comprehensive income was $86.4 million, compared with a loss of $393.3 million a year earlier.
Outlook, risks, and unusual items
- Management said it believed available cash, operating cash flow, and borrowing capacity were sufficient for anticipated short-term needs, including investments, debt service, margin requirements, dividends, and expenses. Long-term liquidity depends on obtaining additional debt financing. The filing provides no earnings or dividend guidance and gives no assurance that distributions will continue at current levels.
- Management noted that Federal Reserve asset purchases and low rates may lower Agency MBS yields and increase refinancing, potentially adversely affecting asset returns. It also stated that Operation Twist generally reduced asset values and interest income. The company expects ongoing sensitivity to rates, yield-curve changes, prepayments, credit spreads, and financing costs.
- Key risks include substantial leverage; short-term funding renewals and margin calls; collateral-value declines; interest-rate and prepayment mismatch; credit losses and illiquidity in non-Agency RMBS and CMBS; counterparty and hedge risks; portfolio fair-value estimates; and dependence on its external manager. California accounted for 49.2% of non-Agency RMBS underlying collateral, a notable geographic concentration.
- At year-end, interest-rate swaps hedged $8.0 billion of borrowings. Derivative liabilities were $436.4 million, and the company had posted $511.7 million of Agency MBS collateral against swap contracts. It was in compliance with derivative financial provisions and repurchase-agreement covenants at December 31, 2012.
- The company reported no other-than-temporary impairment losses in 2012 and a $48.2 million net gain on investment sales. It was awaiting final distribution from the Invesco IMRF Fund after the fund returned substantially all proceeds and repaid PPIP financing in March 2012; $17.1 million of remaining committed capital was due to the fund and AIV.
- Due to a delayed 2012 proxy filing, the company said it could not offer securities under its shelf registration during March 2013 and suspended DRSPP share issuance for that month, with plans to resume around April 1. Subsequent to year-end, it issued 17.25 million common shares at $21 per share, generating approximately $359 million net.
The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting. Management also concluded that disclosure controls and internal control over financial reporting were effective as of year-end. No material legal proceedings were reported.
Most important facts for investors to verify
- Whether net interest margin and earnings can withstand lower asset yields, higher hedging costs, and changes in short-term rates.
- Current repurchase-agreement availability, renewal terms, haircuts, counterparty concentration, and liquidity available to meet margin calls.
- The sensitivity of book value to portfolio and derivative fair values, including the assumptions behind the reported swap liability and collateral requirements.
- Whether the $0.65 quarterly common dividend is supported by recurring earnings and cash generation, given the reduction in annual dividends declared per share.
- The effect of the January 2013 common-stock offering on leverage, book value per share, and investment returns, and the status of the shelf registration and DRSPP suspension.
- Compliance with REIT and Investment Company Act requirements, and the remaining obligations and final distribution associated with the Invesco IMRF Fund and AIV.