Business context and reporting period
Invesco Mortgage Capital Inc. is an externally managed mortgage REIT investing in Agency and non-Agency mortgage-backed securities, GSE credit-risk-transfer securities, commercial mortgage-backed securities and mortgage loans. This Form 10-K reports the fiscal year ended December 31, 2016; selected unaudited fourth-quarter results are also included. The company targets risk-adjusted returns primarily through dividends and secondarily through capital appreciation.
Key financial metrics
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Interest income | $478.7 million | $650.1 million |
| Net interest income | $321.3 million | $372.2 million |
| Net income attributable to common stockholders | $231.5 million; $2.07 basic EPS and $1.98 diluted EPS | $89.8 million; $0.74 basic and diluted EPS |
| Core earnings, non-GAAP | $184.3 million; $1.65 per common share | $216.1 million; $1.78 per common share |
| Operating cash flow | $329.7 million | $358.6 million |
| Net interest margin / effective margin, non-GAAP | 1.92% / 1.35% | 1.69% / 1.15% |
| Common dividends declared per share | $1.60 | $1.70 |
At December 31, 2016, total assets were $15.7 billion, total equity was $2.27 billion, and cash and cash equivalents were $161.8 million. Book value was $17.48 per fully diluted common share, versus $17.14 a year earlier. Borrowings totaled $13.21 billion, including $11.16 billion of repurchase agreements, $1.65 billion of secured loans and $397.0 million carrying value of exchangeable notes. Total debt-to-equity was 5.8x, down from 6.3x; repurchase-agreement debt-to-equity was 5.4x, down from 5.7x.
Fourth-quarter 2016 net income attributable to common stockholders was $270.1 million, or $2.42 basic and $2.15 diluted EPS, compared with $105.8 million, or $0.90 basic and $0.83 diluted EPS, in fourth-quarter 2015. Q4 net interest income was $80.2 million versus $88.9 million. The 2016 Q4 result included a $230.7 million gain on derivative instruments; therefore, the quarter’s GAAP earnings were materially affected by derivative valuation and trading results.
Material changes versus prior period
- Full-year common-stockholder income rose to $231.5 million from $89.8 million, principally because derivative losses narrowed to $62.8 million from $219.0 million. Core earnings declined to $184.3 million from $216.1 million.
- Interest income fell 26% and net interest income fell 14%. Management attributed the decline mainly to a smaller average portfolio, the December 2015 deconsolidation of residential securitizations, and reinvestment into lower-yielding, shorter-duration Agency RMBS.
- The portfolio declined to $15.29 billion from $16.31 billion. Agency RMBS increased to 41% of allocated equity from 37%; residential and commercial credit together decreased to 59% from 63%. Holdings of 15-year fixed-rate Agency RMBS rose to 23% of the investment portfolio from 10%.
- Repurchase-agreement debt declined to $11.16 billion from $12.13 billion. The company repurchased 2.06 million common shares for $25.0 million in 2016, compared with 9.54 million shares for $125.6 million in 2015.
- The company recorded $8.9 million of other-than-temporary impairment losses on RMBS interest-only and non-Agency RMBS securities in 2016. It reported no provision for loan losses on commercial loans.
Outlook, risks and unusual items
No quantified earnings, dividend or portfolio guidance is provided. Management described the outlook as uncertain, anticipating continued modest U.S. economic growth and potentially volatile interest rates. It noted the Federal Reserve’s December 2016 rate increase, rising Treasury yields late in the year, and uncertainty about U.S. policy, Brexit, global conditions and regulatory changes. Management said it believed available liquidity and borrowing capacity would meet anticipated short-term needs, while long-term liquidity depends on access to additional debt financing.
Key risks include changes in interest rates, yield-curve shape, credit spreads and mortgage prepayments; credit losses and property-price declines; short-term repo refinancing, margin calls and counterparty exposure; and the possibility that hedges may not offset asset and funding risks. The company reported a modeled 20.86% decline in projected net interest income under an instantaneous 100-basis-point rate increase and a 1.43% decline in projected portfolio value; management cautioned that actual results could differ significantly. California exposure is notable across non-Agency RMBS, GSE CRT and CMBS collateral, and the commercial loan portfolio consists of mezzanine loans.
Other items to note: the company revised prior-period statements for immaterial errors in accounting for premiums and discounts on certain non-Agency RMBS; it reported $8.9 million of 2016 impairment charges and $69.1 million of realized losses on terminated swaps. It also disclosed a PwC auditor-independence issue involving the SEC Loan Rule and reliance on temporary SEC staff no-action relief through December 20, 2017, while seeking permanent relief. Management and PwC reported effective internal control over financial reporting; PwC’s audit opinion was unqualified. The company reported no material legal proceedings.
Most important facts for investors to verify
- Whether recurring earnings and cash generation support the $1.60 annual common dividend; compare GAAP results with non-GAAP core earnings and review taxable-income disclosures.
- Repo maturity and refinancing exposure, collateral haircuts, covenant compliance, liquidity available for margin calls, and the $400 million exchangeable notes due in 2018.
- How much reported earnings and book value depend on derivative marks, credit-spread movements and fair-value estimates, including the Q4 derivative gain.
- Credit quality, geographic and property concentration, loan performance and mezzanine-loan collateral and seniority risks.
- Resolution of the PwC independence matter before the temporary relief expires, and the implications of the prior-period accounting revisions.