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IVR > SEC Filings for IVR > Form 10-Q on 2-Nov-2012All Recent SEC Filings

Show all filings for INVESCO MORTGAGE CAPITAL INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for INVESCO MORTGAGE CAPITAL INC.


2-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

In this quarterly report on Form 10-Q, or this "Report," we refer to Invesco Mortgage Capital Inc. and its consolidated subsidiaries as "we," "us," "our Company," or "our," unless we specifically state otherwise or the context indicates otherwise. We refer to our external manager, Invesco Advisers, Inc., as our "Manager," and we refer to the indirect parent company of our Manager, Invesco Ltd. (NYSE:IVZ,) together with its consolidated subsidiaries (other than us), as "Invesco."

The following discussion should be read in conjunction with our consolidated financial statements and the accompanying notes to our consolidated financial statements, which are included in Item 1 of this report, as well as the information contained in our most recent Form 10-K filed with the Securities and Exchange Commission (the "SEC").

Forward-Looking Statements

We make forward-looking statements in this Report and other filings we make with the SEC within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and such statements are intended to be covered by the safe harbor provided by the same. Forward-looking statements are subject to substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control. These forward-looking statements include information about possible or assumed future results of our business, investment strategies, financial condition, liquidity, results of operations, plans and objectives. When we use the words "believe," "expect," "anticipate," "estimate," "plan," "continue," "intend," "should," "may" or similar expressions and future or conditional verbs such as "will," "may," "could," "should," and "would," and any other statement that necessarily depends on future events, we intend to identify forward-looking statements. Factors that could cause actual results to differ from those expressed in our forward-looking statements include, but are not limited to:

our business and investment strategy;

our investment portfolio;

our projected operating results;

actions and initiatives of the U.S. government and changes to U.S. government policies, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") and mortgage loan modification programs and our ability to respond to and comply with such actions, initiatives and changes;

our ability to obtain additional financing arrangements and the terms of such arrangements;

financing and advance rates for our target assets;

changes to our expected leverage;

general volatility of the securities markets in which we invest;

general volatility of foreign financial markets and their governments' responses;

interest rate mismatches between our target assets and our borrowings used to fund such investments;

the adequacy of our cash flow from operations and borrowings to meet our short-term liquidity needs;


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our ability to maintain sufficient liquidity to meet any margin calls;

changes in the credit rating of the U.S. government;

changes in interest rates and interest rate spreads and the market value of our target assets;

changes in prepayment rates on our target assets;

the impact of any deficiencies in foreclosure practices of third parties and related uncertainty in the timing of collateral disposition;

effects of hedging instruments on our target assets;

rates of default or decreased recovery rates on our target assets;

modifications to whole loans or loans underlying securities;

the degree to which our hedging strategies may or may not protect us from interest rate volatility;

counterparty defaults;

changes in governmental regulations, tax law and rates, and similar matters and our ability to respond to such changes;

our ability to qualify as a REIT for U.S. federal income tax purposes;

our ability to maintain our exemption from registration under the Investment Company Act of 1940, as amended (the "1940 Act");

availability of investment opportunities in mortgage-related, real estate-related and other securities;

availability of U.S. government Agency guarantees with regard to payments of principal and interest on securities;

availability of qualified personnel;

our understanding of our competition;

changes to accounting principles generally accepted in the United States of America ("US GAAP"); and

market trends in our industry, interest rates, real estate values, the debt securities markets or the general economy.

These forward-looking statements are based upon information presently available to our management and are inherently subjective, uncertain and subject to change. There can be no assurance that actual results will not differ materially from our expectations. We caution investors not to rely unduly on any forward-looking statements and urge you to carefully consider the risks identified under the captions "Risk Factors," "Forward-Looking Statements" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Report and our most recent Form 10-K and subsequent Forms 10-Q, which are available on the SEC's website at www.sec.gov.


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All written or oral forward-looking statements that we make, or that are attributable to us, are expressly qualified by this cautionary notice. We expressly disclaim any obligation to update the information in any public disclosure if any forward-looking statement later turns out to be inaccurate, except as may otherwise be required by law.

Overview

We are a Maryland corporation primarily focused on investing in, financing and managing residential and commercial mortgage-backed securities and mortgage loans. We are externally managed and advised by Invesco Advisers, Inc., our Manager, which is an indirect, wholly-owned subsidiary of Invesco Ltd. We elected to qualify to be taxed as a REIT commencing with our taxable year ended December 31, 2009. Accordingly, we generally will not be subject to U.S. federal income taxes on our taxable income that we distribute currently to our shareholders as long as we maintain our qualification as a REIT. We operate our business in a manner that will permit us to maintain our exclusion from the definition of "investment company" under the Investment Company Act of 1940, as amended (the "1940 Act").

Our objective is to provide attractive risk-adjusted returns to our shareholders, primarily through dividends and secondarily through capital appreciation. To achieve this objective, we primarily invest in the following:

Agency RMBS, which are residential mortgage-backed securities, for which a U.S. government Agency such as the Government National Mortgage Association ("Ginnie Mae") or a federally chartered corporation such as the Federal National Mortgage Association ("Fannie Mae") or the Federal Home Loan Mortgage Corporation ("Freddie Mac") guarantees payments of principal and interest on the securities;

Non-Agency RMBS, which are RMBS that are not issued or guaranteed by a U.S. government agency or a federally chartered corporation;

CMBS, which are commercial mortgage-backed securities; and

Residential and commercial mortgage loans.

We finance our investments in Agency RMBS, non-Agency RMBS and CMBS through short-term borrowings structured as repurchase agreements.

Recent Developments

On July 26, 2012, we completed a public offering of 5.4 million shares of its 7.75% Series A Cumulative Redeemable Preferred Stock, or the Series A Preferred Stock, at the price of $25.00 per share. On August 2, 2012, the underwriters exercised their over-allotment option in part to purchase an additional 200,000 shares of the Series A Preferred Stock, at the price of $25.00 per share. Total net proceeds were approximately $135.4 million, net of issuance costs of $4.6 million. We granted the underwriters a 30-day option to purchase up to an additional 810,000 shares of the Series A Preferred Stock to cover over-allotments, if any.

On September 13, 2012, we declared a dividend of $0.65 per share of common stock. The dividend was paid on October 29, 2012 to shareholders of record as of the close of business on September 24, 2012.

On September 13, 2012, we declared a dividend of $0.479 per share of Series A Preferred Stock. The dividend was paid on October 25, 2012 to shareholders of record as of the close of business on October 1, 2012. The dividend is cumulative from, and including, the date of initial issuance of July 26, 2012 to, but not including, the dividend payment date.


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Factors Impacting Our Operating Results

Our operating results can be affected by a number of factors and primarily depend on, among other things, the level of our net interest income, the market value of our assets and the supply of, and demand for, the target assets in which we invest. Our net interest income, which includes the amortization of purchase premiums and accretion of purchase discounts, varies primarily as a result of changes in market interest rates and prepayment speeds, as measured by the constant prepayment rate ("CPR") on our target assets. Interest rates and prepayment speeds vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty.

Market Conditions

Beginning in the summer of 2007, significant adverse changes in financial market conditions resulted in a deleveraging of the entire global financial system. As part of this process, residential and commercial mortgage markets in the United States experienced a variety of difficulties, including loan defaults, credit losses and reduced liquidity. As a result, many lenders tightened their lending standards, reduced lending capacity, liquidated significant portfolios or exited the market altogether, and therefore, financing with attractive terms was generally unavailable. In response to these unprecedented events, the U.S. government has taken a number of actions to stabilize the financial markets and encourage lending. Significant measures include the enactment of the Emergency Economic Stabilization Act of 2008 to, among other things, establish the Troubled Asset Relief Program ("TARP"), the enactment of the Housing and Economic Recovery Act of 2008 ("HERA"), which established a new regulator for Fannie Mae and Freddie Mac and the establishment of the Term Asset-Backed Securities Loan Facility ("TALF") and the U.S. government's Public Private Investment Program ("PPIP"). Some of these programs are beginning to expire and the impact of the wind-down of these programs on the financial sector and on the economic recovery is unknown. Increased volatility in the RMBS markets may have an adverse effect on the market value and performance of the RMBS in which we invest. Moreover, we rely on financing to acquire, on a leveraged basis, the target assets in which we invest. If market conditions deteriorate further, our lenders may exit the repurchase market, further tighten lending standards, or increase the amount of equity capital required to obtain financing making it more difficult and costly for us to obtain financing.

The Dodd-Frank Act enacted on July 21, 2010, contains numerous provisions affecting the financial and mortgage industries, many of which may have an impact on our operating environment and the target assets in which we invest. Consequently, the Dodd-Frank Act may affect our cost of doing business, may limit our investment opportunities and may affect the competitive balance within our industry and market areas.

On September 21, 2011, the U.S. Federal Reserve announced "Operation Twist," which is a program by which it intends to purchase, by the end of June 2012, $400 billion of U.S. Treasury securities with remaining maturities between 6 and 30 years and sell an equal amount of U.S. Treasury securities with remaining maturities of 3 years or less. Operation Twist could result in a flattening in the yield curve and lower long-term interest rates. In June 2012, the Federal Open Market Committee released a statement that it intends to continue Operation Twist by purchasing Treasury securities with remaining maturities of 6 years to 30 years and sell or redeem an equal amount of Treasury securities with remaining maturities of approximately 3 years or less. This continuation of the maturity extension program should put downward pressure on longer -term interest rates. Lower long-term interest rates could result in increased prepayment rates and a narrowing of our net interest margin. Consequently, Operation Twist and any other future securities purchase programs and actions by the U.S. Federal Reserve could adversely affect our business, financial condition and results of operations and our ability to pay distributions to our shareholders.

The Federal Housing Finance Agency ("FHFA") and the Department of the Treasury introduced the Home Affordable Refinance Program ("HARP") in early 2009. HARP provides borrowers, who may not otherwise qualify for refinancing because of declining home values or reduced access to mortgage insurance, the ability to refinance their mortgages into a lower interest rate and/or more stable mortgage product. On October 24, 2011, the FHFA announced a series of changes to the rules regarding the HARP with the intent of increasing the number of borrowers eligible to refinance their mortgage under this program. The FHFA announced changes to the guidelines related to loan-to-value, appraisals, and certain fees, among other things, subject to a variety of qualifications and the extension of the end date for the HARP until December 31, 2013. It does not change the time period which these loans were originated, maintaining the requirement that the loans must have been guaranteed by Fannie Mae or Freddie Mac on or before May 31, 2009. We do not expect the current HARP or future modifications to have a material impact on our results of operations in future periods.


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On August 1, 2012, the U.S. Federal Reserve announced that it would keep the target range for the federal funds rate at zero to 1/4 percent and it currently anticipates that economic conditions are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014. Low levels of federal funds rates may reduce our borrowing costs. However, there can be no assurance that federal funds rates will remain near zero percent, or that such low levels will reduce our cost of funds.

Investment Activities

As of September 30, 2012, 51.9% of our equity was invested in Agency RMBS, 26.8% in non-Agency RMBS, 19.1% in CMBS, and 2.2% in other investments in unconsolidated ventures. We use leverage on our target assets to achieve our return objectives. For our total investment portfolio, we focus on securities we believe provide attractive returns when levered approximately 3 to 7 times. The leverage on classes of assets may periodically exceed the stated ranges as we adjust our borrowings to obtain the best available source and minimize total interest expense, while maintaining our overall portfolio leverage guidelines.

As of September 30, 2012, we had $10.4 billion in 30-year fixed rate Agency RMBS securities that offered higher coupons and call protection based on the collateral attributes. In addition, we held $2.3 billion in 15-year fixed rate Agency RMBS securities, $651.3 million in hybrid adjustable-rate mortgage Agency RMBS ("ARMs") and $126.0 million in Agency ARM RMBS we believe to have similar durations based on prepayment speeds. As of September 30, 2012, we held $2.6 billion non-Agency RMBS.

As of September 30, 2012, we owned $1.7 billion in CMBS and financed $1.2 billion in repurchase agreements. In addition, as of September 30, 2012, we held $520.6 million in CMOs.

During the nine months ended September 30, 2012, we purchased $7.0 billion of mortgage-backed securities. The average yield on these purchases as of September 30, 2012 is 3.2%.

Portfolio Characteristics

The table below represents the vintage of our credit assets as of September 30,
2012:



                                        2003        2004        2005        2006        2007       2008      2009        2010        2011        2012        Total

Re-REMIC Senior(1)                          -          -           -           -           -          -        0.8 %       5.7 %      49.2 %      13.3 %       69.0 %
Prime                                      0.7 %      1.6 %       1.1 %       3.0 %      12.4 %       -         -           -          0.6 %        -          19.4 %
Alt-A                                       -          -          1.2 %       5.9 %       4.2 %       -         -           -           -           -          11.3 %
Subprime                                    -         0.3 %        -           -           -          -         -           -           -           -           0.3 %


Total Non-Agency                           0.7 %      1.9 %       2.3 %       8.9 %      16.6 %       -        0.8 %       5.7 %      49.8 %      13.3 %      100.0 %

CMBS                                        -          -         20.3 %      23.0 %       1.2 %       -         -         13.6 %      35.2 %       6.7 %      100.0 %

(1) For Re-REMIC Seniors, the table reflects the year in which the resecuritizations were issued. The vintage distribution of the securities that collateralize the Company's Re-REMIC Senior investments is 10.4% 2005, 40.7% 2006 and 48.9% 2007.


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The tables below represent the geographic concentration of the underlying collateral for our MBS portfolio as of September 30, 2012:

         Non-Agency RMBS State   Percentage       CMBS State      Percentage
         California                     51.4 %    California             15.5 %
         Florida                         7.5 %    New York               12.3 %
         New York                        5.6 %    Texas                  10.1 %
         Virginia                        3.2 %    Florida                 5.3 %
         Maryland                        3.1 %    Illinois                4.6 %
         Washington                      2.9 %    Pennsylvania            4.2 %
         New Jersey                      2.8 %    Virginia                3.3 %
         Arizona                         2.5 %    New Jersey              3.2 %
         Illinois                        2.0 %    Massachusetts           3.1 %
         Colorado                        1.9 %    Ohio                    3.0 %
         Other                          17.1 %    Other                  35.4 %

The vintage and geographic concentrations have not significantly changed since June 30, 2012.

Financing and Other Liabilities. We enter into repurchase agreements to finance the majority of our Agency RMBS, non-Agency RMBS and CMBS. These agreements are secured by our Agency RMBS, non-Agency RMBS and CMBS and bear interest at rates that have historically moved in close relationship to the London Interbank Offer Rate ("LIBOR"). As of September 30, 2012, we had entered into repurchase agreements totalling $14.9 billion. We also committed to invest up to $100.0 million in the Invesco Mortgage Recovery Feeder Fund L.P. managed by the Company's Manager ("Invesco IMRF Fund") and Invesco Mortgage Recovery Loans AIV, L.P. ("AIV"), which, in turn, invests in our target assets. As of September 30, 2012, $82.9 million of our commitment to the Invesco IMRF Fund and AIV Fund has been called and we are committed to fund $17.1 million in additional capital.

The Company records the liability for mortgage-backed securities purchased for which settlement has not taken place as an investment related payable. As of September 30, 2012 and December 31, 2011, the Company had investment related payables of $622.7 million and $107.0 million, respectively, of which no items were outstanding greater than thirty days. The change in balance was primarily due to an increase in mortgage-backed security purchases at the quarter ended September 30, 2012.

Hedging Instruments. We generally hedge as much of our interest rate risk as we deem prudent in light of market conditions. No assurance can be given that our hedging activities will have the desired beneficial impact on our results of operations or financial condition. Our investment policies do not contain specific requirements as to the percentages or amount of interest rate risk that we are required to hedge.

Interest rate hedging may fail to protect or could adversely affect us because, among other things:

available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought;

the duration of the hedge may not match the duration of the related liability;

the party owing money in the hedging transaction may default on its obligation to pay;

the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; and

the value of derivatives used for hedging may be adjusted from time to time in accordance with accounting rules to reflect changes in fair value. Downward adjustments or mark-to-market losses would reduce our shareholders' equity.

As of September 30, 2012, we have entered into interest rate swap agreements designed to mitigate the effects of increases in interest rates under a portion of our repurchase agreements. These swap agreements provide for fixed interest rates indexed off of one-month LIBOR and effectively fix the floating interest rates on $7.8 billion of borrowings under our repurchase agreements. As of September 30, 2012, included in this amount we had forward starting swaps with a total notional amount of $1.0 billion, with starting dates ranging from May 24, 2013 to September 5, 2013. We intend to continue to add interest rate hedge positions according to our hedging strategy.


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Book Value per Share

Our book value per common share was $20.93, $18.40 and $16.41 as of September 30, 2012, June 30, 2012 and December 31, 2011, respectively, on a fully diluted basis, after giving effect to our units of limited partnership interest in our operating partnership, which may be converted to common shares at the sole election of the Company. The change in our book value was primarily due to the change in valuation of our investment portfolio and our interest rate hedges that are recorded in Other Comprehensive Income (Loss) on our balance sheet. Refer to Note 3 -"Mortgage-Backed Securities" for the impact of changes in accumulated other comprehensive income on our investment portfolio. The value of our assets and liabilities change daily based on market conditions. Refer to Item 3. "Quantitative and Qualitative Disclosures About Market Risks" for interest rate risk and its impact on fair value.

Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with U.S. GAAP, which requires the use of estimates and assumptions that involve the exercise of judgment and use of assumptions as to future uncertainties. Our most critical accounting policies involve decisions and assessments that could affect our reported assets and liabilities, as well as our reported revenues and expenses. We believe that all of the decisions and assessments upon which our consolidated financial statements are based are reasonable at the time made and based upon information available to us at that time. We rely upon independent pricing of our assets at each quarter's end to arrive at what we believe to be reasonable estimates of fair market value. The complete listing of our Critical Accounting Policies was disclosed in our 2011 annual report on Form 10-K as filed with the SEC on February 29, 2012, and there have been no material changes to our Critical Accounting Policies as disclosed therein.

Expected Impact of New Authoritative Guidance on Future Financial Information

In December 2011, the FASB issued Accounting Standards Updated 2011-11, "Disclosures about Offsetting Assets and Liabilities" (ASU 2011-11). ASU 2011-11 amends Topic 210 to require additional disclosure information about offsetting and related arrangements. Entities will be required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transaction subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements. The objective of this disclosure is to facilitate comparison between those entities that prepare their financial statements on a basis of US GAAP and those entities that prepare their financial statements on the basis of International Financial Reporting Standards (IFRS). The guidance is effective for periods beginning on or after January 1, 2013, and interim periods within those annual periods. We do not believe that the adoption of the amended guidance will have a significant effect on our consolidated financial statements.


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Results of Operations

The table below presents certain information from our Consolidated Statement of
Operations for the three and nine month periods ending September 30, 2012 and
2011:



                                                    Three Months ended           Nine Months ended
                                                       September 30,               September 30,
$ in thousands, except per share data               2012          2011          2012          2011
Revenues
Interest income                                     140,477       138,291       421,442       315,808
Interest expense                                     60,327        50,452       172,312       100,237

Net interest income                                  80,150        87,839       249,130       215,571

Other income                                         16,638         3,049        31,052        15,174

Expenses
Management fee - related party                        9,053         7,884        26,372        17,612
General and administrative                              959           829         3,132         2,855

Total expenses                                       10,012         8,713        29,504        20,467

Net income                                           86,776        82,175       250,678       210,278

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