Business context and reporting period
Invesco Mortgage Capital Inc. is an externally managed mortgage REIT investing in residential and commercial mortgage-backed securities, credit-risk-transfer securities, and mortgage loans. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2017; comparisons are with the corresponding 2016 periods unless noted. Balance-sheet comparisons are with December 31, 2016.
Financial and operating performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Interest income | $127.0 million | $118.8 million | $251.7 million | $245.9 million |
| Net interest income | $82.9 million | $79.2 million | $169.2 million | $156.3 million |
| Net income (loss) | $53.2 million | $(6.0) million | $147.3 million | $(158.3) million |
| Net income (loss) attributable to common stockholders | $46.8 million | $(11.6) million | $134.0 million | $(167.8) million |
| Diluted earnings (loss) per share | $0.41 | $(0.10) | $1.15 | $(1.49) |
| Core earnings per share (non-GAAP) | $0.41 | $0.42 | $0.82 | $0.87 |
- Net interest margin was 1.91% in Q2 and 1.94% for the first half, versus 1.90% and 1.85%, respectively. On the company’s non-GAAP effective basis, margin was lower year over year: 1.31% for Q2 and 1.30% for the first half.
- Q2 results included a $53.5 million net loss on derivatives, partly offset by $11.2 million in net investment gains and $21.4 million in credit-derivative income. The smaller derivative loss than in Q2 2016 was a major factor in the earnings improvement.
- For the first half, operating cash flow was $154.4 million, investing cash flow was a use of $919.6 million, and financing cash flow provided $667.5 million. Cash and equivalents were $64.1 million at June 30, down from $161.8 million at year-end.
- Total assets were $16.67 billion and total equity was $2.36 billion. Mortgage-backed and credit-risk-transfer securities had a fair value of $16.08 billion. Book value per diluted common share rose 4.5% to $18.27 from $17.48 at year-end, primarily reflecting tighter spreads and higher portfolio valuations.
- Total borrowings were $13.99 billion: $12.12 billion in repurchase agreements, $1.65 billion in secured loans, and $218.8 million carrying value of exchangeable notes. Debt-to-equity was 5.9x; repurchase-agreement debt-to-equity was 6.1x. Repurchase agreements had a weighted-average rate of 1.56% and average remaining maturity of 21 days.
Material changes versus comparable periods
- Interest income rose 7% in Q2 and 2% in the first half, mainly because average earning assets increased. The company expanded 30-year fixed-rate Agency RMBS holdings; these represented about 31% of the investment portfolio at quarter-end, versus 20% at year-end 2016.
- Net interest income increased, but the company’s non-GAAP core earnings declined to $46.1 million in Q2 from $47.3 million and to $91.0 million for the first half from $98.3 million. Management attributed the first-half decline chiefly to lower effective net interest income and losses from unconsolidated ventures.
- Borrowings increased from $13.21 billion at year-end, while cash declined. The company repurchased $181.2 million principal amount of exchangeable notes during the first half, ahead of their March 2018 maturity, recording a $5.2 million extinguishment loss.
- Common dividends declared were $0.40 per share for Q2, unchanged from Q2 2016. The filing also reports preferred dividends and continued quarterly distributions as management’s intention, subject to operating and debt-service requirements.
Outlook, commentary and risks
No earnings or dividend guidance was provided. Management said it believed available cash flow and borrowing capacity could meet anticipated short-term liquidity needs, but long-term liquidity depends on obtaining additional debt financing. It described Q2 markets as less volatile with generally tighter credit spreads, while noting uncertainty about economic indicators, policy, and geopolitical conditions.
- Financing is heavily reliant on short-term repurchase agreements, which are refinanced at prevailing market rates. Falling collateral values, wider spreads, higher haircuts, or counterparty actions can trigger margin calls; management cautioned that adequate liquidity to meet all calls cannot be assured. Repurchase collateral coverage was 110% at quarter-end.
- Interest-rate, spread, prepayment, extension, credit, property-value, and foreign-exchange risks may affect earnings, asset values, and liquidity. In the company’s modeled parallel-rate sensitivity, a 100-basis-point increase implied a 22.49% decline in projected net interest income and a 1.30% decline in portfolio value; actual outcomes may differ.
- Other commitments included $12.6 million of undrawn commitments to affiliated unconsolidated ventures and $6.4 million of unfunded commercial-loan commitments. The company reported compliance with financing covenants, no legal proceedings at quarter-end, and no material change to previously disclosed risk factors.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether core earnings and effective net interest margin stabilize as funding costs rise and leverage remains high.
- How short-term repo renewals, haircuts, collateral marks, and margin-call liquidity evolve; assess the significance of the $64.1 million cash balance and unsettled investment payables.
- Whether the $0.40 common dividend is supported by recurring earnings and cash generation, rather than market-value or derivative movements.
- Performance and concentration of the expanded Agency RMBS position, as well as credit quality and valuation assumptions for non-Agency RMBS, GSE CRT, and CMBS.
- Repayment or refinancing plans for the remaining exchangeable notes due March 2018 and the longer-term availability of secured and repo funding.