Invesco Mortgage Capital Inc. — 2014 Form 10-K
Business context and reporting period
Externally managed mortgage REIT investing in Agency and non-Agency residential mortgage-backed securities, commercial mortgage-backed securities, GSE credit-risk-transfer securities, and residential and commercial mortgage loans. This annual report covers the fiscal year ended December 31, 2014; comparative results are primarily for 2013.
Key financial metrics
| Metric | 2014 | 2013 |
|---|---|---|
| Total interest income | $693.9 million | $682.4 million |
| Net interest income | $412.0 million | $350.1 million |
| Net interest margin (GAAP) | 1.89% | 1.48% |
| Effective net interest income and margin (non-GAAP) | $297.4 million; 1.23% | $350.1 million; 1.48% |
| Net income (loss) attributable to common stockholders | ($216.8 million); EPS ($1.76) | $130.8 million; EPS $0.99 |
| Core earnings and core EPS (non-GAAP) | $233.0 million; $1.89 | $288.5 million; $2.17 |
| Cash provided by operating activities | $379.7 million | $490.4 million |
| Total assets / total equity, at year-end | $21.23 billion / $2.64 billion | $20.35 billion / $2.40 billion |
| Cash and cash equivalents, at year-end | $164.1 million | $210.6 million |
| Book value per diluted common share | $18.82 | $17.97 |
| Common dividends declared per share | $1.95 | $2.30 |
Year-end financing included $13.62 billion of repurchase agreements, $1.25 billion of secured advances, $2.93 billion of asset-backed securities issued by consolidated trusts, and $400 million of 5.00% exchangeable senior notes due 2018. Total debt-to-equity was 6.9x and repurchase-agreement debt-to-equity was 5.4x, versus 7.3x and 5.8x, respectively, in 2013. Investing activities used $912.4 million of cash in 2014.
Material changes versus 2013
- GAAP net loss attributable to common stockholders of $216.8 million replaced 2013 income of $130.8 million. The principal driver was the accounting change after the company discontinued cash-flow hedge accounting for interest-rate swaps: 2014 derivative losses were recognized in earnings rather than, in part, in other comprehensive income.
- Net derivative loss was $487.5 million, including $223.9 million of unrealized swap fair-value losses and $85.2 million amortization of deferred swap losses. Management said the accounting change did not alter its risk-management practices. Core earnings, which exclude specified realized and unrealized items, were $233.0 million, down from $288.5 million; this non-GAAP measure is not a substitute for GAAP income or operating cash flow.
- Net interest income increased, but the effective margin fell to 1.23% from 1.48%, reflecting swap costs and deferred-loss amortization under the non-GAAP presentation.
- The portfolio shifted away from lower-coupon 30-year Agency RMBS, reduced from $6.7 billion to $4.8 billion, and toward hybrid ARMs, credit assets, CMBS, and residential loans. CMBS holdings grew to $3.47 billion from $2.63 billion; residential loans held for investment increased to $3.37 billion from $1.81 billion.
- The company issued $149.9 million net from Series B preferred stock, repurchased $21.1 million of common stock, reduced repurchase-agreement debt, and added $1.25 billion of FHLBI secured advances.
Outlook, management commentary, and principal risks
Management reported that long-term U.S. Treasury yields declined during 2014, while credit spreads generally narrowed over the year and GSE CRT spreads widened in the second half. It described the domestic economy and housing market as improving, but noted global growth and deflation concerns. Management said it had reduced portfolio interest-rate sensitivity, while remaining exposed to credit-spread volatility. It expected operating cash flow and available borrowing capacity to cover anticipated short-term liquidity needs, but stated that longer-term needs depend on obtaining additional debt financing. No formal earnings or dividend guidance is provided.
- Funding and liquidity: short-term repurchase agreements are subject to refinancing, changing haircuts, collateral revaluation and margin calls. Management cautions that available liquidity may not be sufficient in stressed conditions and that forced asset sales could cause losses.
- Interest-rate and prepayment exposure: rising short-term rates or a flattening yield curve can compress asset-funding spreads; slower prepayments can extend asset duration and weaken hedge effectiveness. The company’s model estimated that a 100-basis-point rate rise would increase projected net interest income 10.5% and reduce portfolio value 1.29%; a 100-basis-point decline would reduce projected net interest income 51.1% and increase portfolio value 0.32%. These are scenario estimates, not forecasts.
- Credit, valuation and concentration: non-Agency RMBS, GSE CRT, CMBS, and subordinate loans bear credit risk; residential loan collateral was concentrated in California (53.2%). MBS fair values and loan-loss estimates rely on models, assumptions and third-party pricing.
- Accounting and distributions: derivative mark-to-market volatility affects reported GAAP earnings. REIT taxable income may differ from GAAP income; common dividends declined to $0.45 per share in the fourth quarter from $0.50 in each of the first three quarters. The board has not established a minimum distribution.
- Other material considerations include counterparty and hedging risk, dependence on the external Manager and related-party conflicts, maintaining REIT and Investment Company Act exclusions, and the $400 million exchangeable notes’ repayment or refinancing risk. The filing reports no material legal proceedings at year-end and no subsequent events requiring disclosure.
Most important facts for investors to verify
- Reconcile the $216.8 million GAAP common-stockholder loss with $233.0 million of core earnings; review the derivative-loss components and deferred swap-loss amortization.
- Assess liquidity against short-term repo maturities, collateral haircuts, margin requirements and derivative collateral obligations; confirm the availability and terms of FHLBI and other financing.
- Review changes in portfolio mix, credit quality, geographic concentration, loan performance and fair-value assumptions, especially the California exposure.
- Evaluate whether cash flow and REIT taxable income support common and preferred distributions, and account for preferred-stock claims and exchangeable-note dilution or repayment.
- Compare the company’s rate-sensitivity scenarios and leverage with actual portfolio and funding changes; the filing cautions that actual outcomes may differ materially from modeled estimates.