Invesco Mortgage Capital Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. Unless noted otherwise, amounts are U.S. dollars. Prior-period figures were restated; the filing says to read this report with the company’s amended 2014 Form 10-K.
Business context and financial performance
The externally managed REIT invests in residential and commercial mortgage securities and loans, funded largely through repurchase agreements, secured advances and securitization debt. Its stated objective is to provide returns primarily through dividends and secondarily through capital appreciation.
| Metric | Q3 2015 | Q3 2014, restated | First nine months 2015 | First nine months 2014, restated |
|---|---|---|---|---|
| Interest income | $161.4 million | $164.8 million | $490.0 million | $503.2 million |
| Net interest income | $92.2 million | $94.5 million | $278.0 million | $294.9 million |
| Net income (loss) attributable to common stockholders | $(144.6) million | $(2.8) million | $(22.1) million | $(135.4) million |
| Basic and diluted loss per share | $(1.18) | $(0.02) | $(0.18) | $(1.10) |
| Common dividend declared per share | $0.40 | $0.50 | $1.30 | $1.50 |
Margins and adjusted earnings: GAAP net interest margin was 1.67% for Q3 and 1.64% for the nine-month period, down from 1.75% and 1.81%, respectively. Non-GAAP effective interest rate margin was 1.11% and 1.12%, compared with 1.18% and 1.20%. Non-GAAP core earnings were $49.2 million ($0.40 per share) in Q3 and $161.3 million ($1.31 per share) for nine months, versus $54.5 million ($0.44) and $173.4 million ($1.41).
Balance sheet, cash flow and leverage
- At September 30, total assets were $20.78 billion, total liabilities $18.35 billion and total equity $2.43 billion. Mortgage-backed and credit risk transfer securities were $16.81 billion; residential loans were $3.31 billion.
- Cash and cash equivalents were $76.7 million, down from $164.1 million at December 31, 2014. Nine-month operating cash flow was $276.0 million; investing activities provided $354.7 million and financing activities used $718.2 million.
- Repurchase agreements totaled $12.91 billion, secured loans $1.68 billion, exchangeable senior notes $400 million and securitization ABS $2.86 billion. Total debt-to-equity was 7.3x, versus 6.9x at year-end; management reported effective debt-to-equity of 6.2x and repo debt-to-equity of 5.7x.
- Book value per diluted common share was $17.66, down from $18.82 at December 31, 2014. Management attributed the decrease primarily to derivative losses and changes in investment portfolio valuations.
- The company repurchased 3.70 million shares during the nine months at an average $13.53 per share, for a net cost of $50.0 million. It declared a $0.40 common dividend for payment in October 2015.
Changes versus comparable periods
- Q3 common-stockholder loss widened sharply from the prior-year quarter, principally because net derivative losses were $220.6 million versus $3.7 million. Interest income and net interest income also declined.
- The nine-month common-stockholder loss narrowed from $135.4 million to $22.1 million, mainly because investment results improved to a $10.1 million net gain from an $86.3 million loss, and derivative losses were lower than in 2014.
- Average portfolio yield declined: 3.20% for both Q3 and nine months, versus 3.37% and 3.41%. Management cited portfolio mix and lower reinvestment yields. Average earning assets increased, partly due to additional residential loan securitizations.
- Repurchase agreement borrowings declined from $13.62 billion at year-end, while secured loans rose from $1.25 billion to $1.68 billion. The weighted-average remaining maturity of borrowings was 380 days, compared with 335 days at year-end.
Outlook, risks and unusual items
- No specific earnings or dividend guidance is provided. Management said it believes operating cash flow and available borrowing capacity can cover anticipated short-term needs, but long-term liquidity depends on obtaining additional debt financing. It intends to continue regular quarterly distributions, subject to operating requirements and debt service.
- Management described Q3 markets as more volatile, with wider credit spreads and tighter financial conditions. It considered low interest rates supportive of real estate and Agency RMBS, while noting uncertainty around Federal Reserve policy, economic growth, financing conditions and spreads.
- The company is highly leveraged and exposed to changes in rates, spreads, prepayments, collateral values, counterparty credit and repo refinancing. Falling collateral values or higher haircuts can trigger margin calls; management cautioned there is no assurance liquidity will be sufficient. At September 30, repurchase collateral coverage was 112%.
- A modeled, instantaneous 100-basis-point rate increase was estimated to raise projected net interest income 11.64% and lower projected portfolio value 0.92%; a 100-basis-point decrease was estimated to lower net interest income 52.23% and portfolio value 0.25%. These are management estimates based on a static portfolio and stated assumptions, including a zero-rate floor.
- Restatement and controls: The company previously concluded that its 2013–Q1 2015 financial statements required restatement, including because GSE CRTs and Agency MBS interest-only securities had been improperly accounted for as investment securities rather than hybrid instruments with embedded derivatives. A material weakness in internal control remained unremediated at September 30, 2015, and disclosure controls were deemed ineffective. Management reported new technical-accounting review procedures but said they had not operated long enough to demonstrate remediation.
- Other notable items: Q3 included approximately $0.75 million of restatement-related professional fees. The company reported no other-than-temporary impairment losses for the periods presented, no legal proceedings as of quarter-end, and compliance with repo covenants. It accepted an offer to terminate its CDS in October for approximately $1.0 million.
Important facts for investors to verify
- Review the amended prior filings and restatement disclosures, including the accounting treatment of GSE CRTs and Agency MBS interest-only securities.
- Track whether the material weakness is remediated and whether disclosure controls become effective.
- Assess derivative mark-to-market volatility, hedge effectiveness and collateral or cash demands under stressed rate and spread scenarios.
- Monitor repo renewal terms, haircuts, counterparty concentration, available liquidity and the company’s reliance on FHLBI advances.
- Compare core earnings and dividend levels with GAAP results and cash generation; core earnings are a non-GAAP measure and are not a measure of liquidity or cash available for distributions.
- Verify subsequent book value, leverage and dividend coverage, given the quarter-end decline in book value and the high debt-to-equity ratio.