Invesco Mortgage Capital Inc. — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013. Unaudited consolidated results; amounts below are U.S. dollars. The company is an externally managed mortgage REIT investing in Agency and non-Agency mortgage securities and mortgage loans.
Key financial results
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Interest income | $171.3m | $140.5m | $507.5m | $421.4m |
| Net interest income | $81.7m | $80.2m | $270.9m | $249.1m |
| Net income (loss) | ($6.0m) | $86.8m | $224.7m | $250.7m |
| Net income (loss) attributable to common shareholders | ($8.7m) | $83.1m | $214.2m | $245.0m |
| Basic EPS | ($0.06) | $0.72 | $1.61 | $2.12 |
| Core earnings per share, non-GAAP | $0.50 | $0.62 | $1.70 | $1.93 |
| Common dividend declared per share | $0.50 | $0.65 | $1.80 | $1.95 |
Q3 net interest margin was 1.38%, down from 1.64%; nine-month margin was 1.53%, down from 1.86%. Average portfolio yield was 3.35% in Q3 and 3.27% for the nine-month period, versus 3.31% and 3.55%, respectively. The reported average hedged cost of funds rose to 1.97% in Q3 from 1.67%; nine-month cost was 1.74% versus 1.69%.
Balance sheet, leverage and cash flow
- At September 30, total assets were $20.91bn, total liabilities $18.35bn and total equity $2.55bn. Mortgage-backed securities were $18.81bn; cash and cash equivalents were $199.1m.
- Borrowings comprised $15.90bn of repurchase agreements, $1.41bn of asset-backed securities (ABS) and $400m of exchangeable senior notes. Reported period-end debt-to-equity was 6.94x, versus 5.75x at year-end 2012.
- Book value per common share was $17.64, down from $20.83 at December 31, 2012. The company attributed the decline primarily to valuation changes in investments and interest-rate hedges.
- For the first nine months, operating cash flow was $381.3m, investing cash outflow was $2.62bn and financing cash inflow was $2.15bn; cash decreased $87.4m to $199.1m.
- Net unrealized losses in other comprehensive income were $406.2m for the nine months, compared with a $512.1m gain in 2012. Q3 recorded a $44.5m OCI gain, versus $291.9m a year earlier.
Material changes and unusual items
- Q3 common-shareholder results swung to a loss from substantial year-earlier income. The main drag included a $69.3m net loss on investment sales (versus a $12.8m gain) and a $6.9m loss on interest-rate derivatives (versus a $0.8m loss). Management reported Q3 non-GAAP core earnings of $67.5m, or $0.50 per share; this measure excludes investment-sale gains or losses and realized and unrealized interest-rate derivative gains or losses and is not a substitute for GAAP income or cash flow.
- The company expanded its portfolio and financing: it purchased controlling interests in four residential-loan securitization trusts during the nine months, consolidating $1.54bn of assets and $1.42bn of non-recourse ABS liabilities. It also originated a commercial mezzanine loan; commercial loans held for investment totaled $17.4m.
- January’s common-stock offering and the dividend reinvestment plan generated about $396.4m in net proceeds during the nine months. The company also issued $400m of 5.00% exchangeable notes due 2018, increasing funding costs and potential future share dilution.
- Management reported the residential-loan portfolio had $2.3m of 30-day delinquencies and no loans 60 or more days delinquent. California represented 49.9% of its residential-loan principal balance.
Outlook, liquidity and principal risks
No specific earnings or dividend guidance was provided. Management said it believed operating cash flow and available borrowing capacity would cover anticipated short-term liquidity needs, including investments, borrowings, margin requirements and dividends, but cautioned that adequate liquidity to meet margin calls cannot be assured. Longer-term liquidity depends on obtaining additional debt financing.
- Most securities financing relies on short-term repurchase agreements that are regularly refinanced. Falling collateral values, wider credit spreads or higher interest rates may trigger margin calls, raise haircuts or restrict financing; forced asset sales could result.
- At quarter-end, repurchase agreements were collateralized by $17.5bn of company MBS, a 110% collateral ratio. Weighted-average haircuts were approximately 4.51% for Agency RMBS, 17.72% for non-Agency RMBS and 18.26% for CMBS. The company reported compliance with repurchase and derivative covenants.
- Interest-rate exposure, prepayment and extension risk, credit losses, real-estate values, counterparty performance and the timing or scale of Federal Reserve asset-purchase tapering may affect earnings, portfolio values and liquidity. The filing’s modeled parallel-rate scenario estimated that a 100-basis-point increase would raise projected net interest income 12.93% and reduce portfolio value 1.26%; a 100-basis-point decrease would reduce projected net interest income 58.95% and increase portfolio value 0.60%. These are model estimates, not forecasts.
- Management said it believed the company met REIT requirements and remained outside the Investment Company Act definition. Failure to maintain those statuses could materially affect operations and distributions. The company reported no material changes to previously disclosed risk factors, no legal proceedings, and effective disclosure controls.
Investor verification priorities
- Reconcile GAAP Q3 loss with reported core earnings and assess the sensitivity of core earnings to excluded sale and derivative results.
- Review book-value changes, unrealized losses and the assumptions used to value mortgage securities, loans and derivatives.
- Assess refinancing and margin-call capacity against short-term repo funding, leverage, collateral haircuts and derivative collateral requirements.
- Evaluate the performance, credit quality and geographic concentration of the newly consolidated residential loans and the related non-recourse ABS.
- Check whether the $0.50 common dividend is supported by sustainable earnings and liquidity, and consider potential dilution from the exchangeable notes and equity issuance.