Invesco Mortgage Capital Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Unaudited consolidated results. Dollar amounts below are in millions unless otherwise stated.
Business context
The company is an externally managed mortgage REIT investing in agency and non-agency residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS), and mortgage-related investments. It primarily funds its portfolio through short-term repurchase agreements and seeks returns mainly through dividends. It reported a $18.3 billion MBS portfolio at quarter-end.
Key financial metrics
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Interest income | $140.5 | $138.3 | $421.4 | $315.8 |
| Interest expense | $60.3 | $50.5 | $172.3 | $100.2 |
| Net interest income | $80.2 | $87.8 | $249.1 | $215.6 |
| Net income | $86.8 | $82.2 | $250.7 | $210.3 |
| Net income attributable to common shareholders | $83.1 | $81.1 | $245.0 | $206.3 |
| Common EPS | $0.72 | $0.79 | $2.12 | $2.70 |
| Common dividends declared per share | $0.65 | $0.80 | $1.95 | $2.77 |
| Net interest margin | 1.64% | 2.40% | 1.86% | 2.68% |
Balance sheet and funding: At September 30, total assets were $18.7 billion, total liabilities $16.1 billion, and total equity $2.6 billion. Repurchase agreements totaled $14.9 billion, up from $12.3 billion at December 31, 2011. Quarter-end debt-to-equity was 5.75x; average debt-to-equity during Q3 was 6.20x. Repo borrowings had a 0.68% weighted-average rate and 19-day weighted-average remaining maturity. Cash and cash equivalents were $190.8 million, with a further $13.5 million of restricted cash.
Cash flow: For the first nine months, operating activities provided $309.1 million; investing activities used $2.9 billion; and financing activities provided $2.6 billion. Cash ended the period at $190.8 million. These flows reflect substantial securities purchases and sales, principal repayments, and repo financing activity.
Portfolio and book value: Quarter-end MBS fair value was $18.3 billion: 51.9% of equity was allocated to agency RMBS, 26.8% to non-agency RMBS, 19.1% to CMBS, and 2.2% to unconsolidated ventures. Fully diluted book value per common share was $20.93, versus $18.40 at June 30, 2012 and $16.41 at December 31, 2011.
Material changes versus comparable periods
- Q3 net interest income fell 9% year over year despite higher interest income, as interest expense increased. The reported net interest margin declined to 1.64% from 2.40%.
- Nine-month net interest income rose 16%, while common EPS declined to $2.12 from $2.70. Management attributed higher total earnings but lower per-share results mainly to portfolio growth, changes in asset mix, and equity issuance.
- Average portfolio yield fell to 3.31% from 4.16% in Q3 and to 3.55% from 4.24% for the nine-month period. Management cited greater allocation to lower-yielding agency RMBS. Hedged cost of funds was 1.67% in Q3 and 1.69% for the nine months.
- Other income increased to $16.6 million in Q3 from $3.0 million, including $12.8 million of investment-sale gains. Nine-month investment-sale gains were $25.0 million, versus $8.4 million.
- Other comprehensive income was $291.9 million in Q3 and $512.1 million for the nine months, compared with losses in 2011. MBS fair-value gains drove much of the increase in book value; these marks are generally recorded in equity, not current earnings.
Outlook, risks, contingencies, and unusual items
- Management outlook: No quantified earnings or dividend guidance was provided. Management said available cash flow and borrowing capacity were expected to meet anticipated short-term liquidity needs, including investments, financing, and distributions. Long-term liquidity depends on obtaining additional debt financing.
- Leverage and liquidity risks: The portfolio is financed primarily with short-term repos that are regularly refinanced. Falling collateral values or higher haircuts can trigger margin calls; lenders may tighten terms, reduce financing, or terminate transactions. Management stated it believed liquidity was sufficient but cautioned that this could not be assured under adverse conditions.
- Interest-rate and prepayment risks: The filing describes spread compression, fair-value losses, faster premium amortization, and extension risk as possible outcomes of changing rates and prepayment speeds. The company had $7.75 billion of interest-rate swaps designated as cash-flow hedges, including $1.0 billion of forward-starting swaps. Its modeled sensitivity showed that a parallel 100-basis-point rate increase corresponded to an 18.45% increase in projected net interest income and a 1.36% decline in projected portfolio value; a 100-basis-point decrease corresponded to a 47.51% decline in projected net interest income and a 0.33% decline in portfolio value. These are model estimates, not forecasts.
- Derivatives and collateral: Derivative liabilities were $471.8 million at fair value. The company had posted $547.3 million of Agency RMBS as swap collateral. Certain derivative agreements include default triggers tied to debt defaults, declines in net asset value or equity, or minimum equity/market-value thresholds. The company reported compliance with these provisions at September 30, 2012.
- Credit exposure and commitments: The company had one credit default swap with $87.1 million notional exposure and $13.5 million of collateral held by the counterparty. It also had $17.1 million of remaining capital commitments to unconsolidated ventures. Management reported no other-than-temporary impairment of MBS for the periods presented.
- Capital and distributions: The company issued 5.6 million shares of 7.75% Series A cumulative redeemable preferred stock, receiving $135.4 million net of issuance costs. The preferred dividend is cumulative; the company declared a $0.479 per-share preferred dividend and a $0.65 common dividend for Q3. The preferred shares are redeemable at the company’s option after July 26, 2017.
- Other items: The company reported no subsequent events, legal proceedings as of quarter-end, defaults on senior securities, or material changes to previously disclosed risk factors. Disclosure controls were assessed as effective; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether portfolio growth can offset continued pressure on asset yields, net interest margin, and common EPS.
- Repo refinancing capacity, counterparty concentration, collateral haircuts, and liquidity available to meet potential margin calls.
- How interest-rate swaps, prepayments, and extension risk affect earnings, fair value, and the substantial derivative collateral requirement.
- The durability of investment-sale gains and unrealized MBS valuation gains, and the credit performance of non-agency RMBS and CMBS.
- The company’s ability to sustain common and preferred dividends while meeting REIT distribution requirements and funding commitments.
- The filing reports fully diluted book value per share of $20.93; investors should confirm the calculation and distinguish reported equity marks from realized earnings.