Invesco Mortgage Capital Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. The company is an externally managed mortgage REIT investing in residential and commercial mortgage securities and loans. Unless noted, amounts are U.S. dollars.
Financial performance and position
| Metric | Q1 2017 | Q1 2016 / prior period |
|---|---|---|
| Interest income | $124.6 million | $127.1 million |
| Interest expense | $38.4 million | $50.1 million |
| Net interest income | $86.3 million | $77.0 million |
| Net income (loss) | $94.0 million | $(152.3) million |
| Net income (loss) attributable to common stockholders | $87.1 million; $0.78 basic and $0.73 diluted EPS | $(156.2) million; $(1.38) basic and diluted EPS |
| Common dividend declared | $0.40 per share | $0.40 per share |
| Operating cash flow | $70.9 million | $78.9 million |
| Cash and cash equivalents | $55.9 million | $161.8 million at Dec. 31, 2016 |
| Total assets / total equity | $16.7 billion / $2.32 billion | $15.7 billion / $2.27 billion at Dec. 31, 2016 |
| Total borrowings | $14.19 billion; debt-to-equity 6.1x | $13.21 billion; debt-to-equity 5.8x at Dec. 31, 2016 |
| Diluted book value per common share | $17.95 | $17.48 at Dec. 31, 2016 |
Net interest margin was 1.98%, up from 1.82% a year earlier; the company’s non-GAAP effective interest rate margin was 1.30%, down from 1.50%. Core earnings were $44.9 million, or $0.40 per basic common share, versus $51.0 million, or $0.45, in Q1 2016. These non-GAAP measures are not substitutes for GAAP results.
Investing activities used $1.10 billion of cash, chiefly reflecting $1.85 billion of MBS and credit-risk-transfer purchases. Financing activities provided $928.0 million, including a $1.13 billion net increase in repurchase-agreement borrowings. The investment portfolio was $16.23 billion at quarter-end, up from $15.29 billion at year-end.
Material changes versus comparable periods
- Common-stockholder earnings swung to profit from a substantial loss in Q1 2016, principally because derivative results improved: a $5.5 million gain in Q1 2017 versus a $238.5 million loss a year earlier. The 2016 loss included a $166.7 million unrealized derivative loss.
- Net interest income rose by $9.3 million despite lower interest income, mainly because reported interest expense declined. The comparison was affected by deferred swap accounting: amortization reduced Q1 2017 expense by $6.3 million, while amortization increased Q1 2016 expense by $12.9 million.
- The company purchased $1.7 billion of 30-year fixed-rate Agency RMBS. Such securities rose to about 28% of the investment portfolio from 20% at year-end. Agency RMBS increased to 39% of equity allocation from 34% a year earlier.
- Repurchase agreements increased to $12.29 billion from $11.16 billion at year-end. In March, the company retired $150 million principal amount of exchangeable notes for $153.8 million, recording a $4.7 million extinguishment loss. Remaining note principal was $250 million, due March 2018.
- Diluted book value per share increased 2.7% from year-end, which management attributed primarily to wider interest-rate swap spreads and higher valuations of credit-risk-transfer securities.
- The prior-year 2016 results were revised for an immaterial correction to non-Agency RMBS premium and discount accounting. The revision increased reported Q1 2016 interest income by $1.2 million; the comparative figures above reflect the revised amounts.
Outlook, risks and unusual items
- Management said current cash flows and available borrowing capacity should cover anticipated short-term needs, including investments, borrowings, expenses, margin requirements and distributions. It cautioned that sufficient liquidity to meet margin calls cannot be assured; longer-term needs depend on obtaining debt financing.
- The company intends to continue regular quarterly common and preferred dividends. It declared a $0.40 common dividend and $0.4844 per-share dividends for each preferred series. REIT status generally requires annual distribution of at least 90% of REIT taxable income, subject to the filing’s qualifications.
- Key exposures include short-term repo refinancing, rising funding costs, interest-rate and spread movements, mortgage prepayment and extension risk, credit losses, collateral valuation and margin calls, and counterparty or covenant events. A parallel 100-basis-point rate increase was modeled to reduce projected net interest income by 22.62% and portfolio value by 1.58%; these are estimates under stated assumptions, not forecasts.
- Repo collateral coverage was 111% at March 31, 2017. The reported average repo haircut varied by asset class from 4.9% for Agency RMBS to 24.5% for GSE CRT. The company was in compliance with repurchase and derivative financial covenants.
- Unfunded commitments included $13.2 million to affiliated-manager-sponsored unconsolidated ventures and $7.6 million on commercial loans. The company reported no required commercial-loan loss allowance and no legal proceedings as of quarter-end.
- No quantitative earnings or dividend guidance was provided. Management described Q1 market conditions as generally supportive of credit spreads, while citing economic-data uncertainty, geopolitical concerns, and evolving bank regulation that could affect financing terms.
Most important facts for investors to verify
- Whether derivative gains and deferred swap-cost amortization are masking weaker underlying spread economics; compare GAAP net interest margin with effective margin and core earnings.
- How the greater Agency RMBS allocation, leverage increase and short-term repo maturities affect earnings sensitivity, book value and margin-call liquidity.
- Whether liquidity remains adequate as cash fell to $55.9 million and unsettled investment receivables/payables changed substantially during the quarter.
- The timing and funding plan for the $250 million exchangeable notes due in March 2018, as well as continued access to repo and FHLBI financing.
- The durability of the $0.40 common quarterly dividend relative to core earnings of $0.40 per share, taxable income and cash available for distribution.
- The assumptions behind portfolio fair values, credit performance and the interest-rate sensitivity analysis, including prepayment and spread scenarios.