What To Expect From Your mREIT When It Reports 4Q
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Invesco Mortgage Capital (NYSE: IVR) operates as a well diversified mortgage REIT with a market cap of around $2.5 billion. The company invests in both residential and commercial mortgage backed securities to provide higher risk adjusted returns to its investors through both dividends and capital appreciation. The MBS portfolio that the company is invested in is financed by short-term borrowings (repurchase agreements). The company has a large concentration in Agency residential MBS, while a small proportion of non-Agency residential MBS also exist. The company is also invested in residential and commercial loans. Invesco yields 12.24%, while 10-year Treasuries are yielding only 2%.
Within the mortgage REITs sector, Annaly Capital Management (NYSE: NLY) happens to be a competitor of Invesco. Annaly employs the same leverage as Invesco does; however, Annaly is exclusively invested in longer duration Agency residential mortgage backed securities with higher coupons and prepayments speeds. In order to diversify its portfolio under the current challenging macroeconomic environment, Annaly is in aggressive pursuit of another mortgage REIT (CreXus Investments) that invests in commercial MBS. Annaly currently offers a dividend yield of 12%, and is up 6% since the beginning of this year.
In contrast, American Capital Agency (NASDAQ: AGNC), another mortgage REIT that employs 7.3 times leverage, is considered to have a MBS portfolio with prepayment protected attributes. The company is exclusively invested in Agency residential mortgage; however, it prefers HARP MBS with low loan balances and shorter durations. These characteristics reduce the repayment speeds. The stock offers a dividend yield of 15.9%, and is up 9% since the beginning of the year.
Armour Residential REIT (NYSE: ARR) is a similar pure play mortgage REIT that invests in Agency fixed rate securities and ARMs despite the fact that its charter allows for the addition of non-Agency securities. The stock is up 11% since the beginning of the year and yields 13.4%. The company employs 8.9 times leverage and was forced to cut its monthly dividends in 2012.
AG Mortgage Investment Trust (NYSE: MITT) is a hybrid mortgage REIT that invests in Agency MBS, Non-Agency RMBS and Commercial MBS. Its well diversified portfolio contains 87% of Agency RMBS, followed by 10% of non-Agency MBS and 3% of Commercial MBS. I am bullish on the stock due to its attractive relative valuations coupled with a diversified asset mix, enhancing its dividend paying ability. The stock has increased its quarterly dividend twice during the prior year and is currently yielding 12.5%. The stock is up 9% since the beginning of this year.
Recent Quarter’s Earnings
Invesco Mortgage surprised the Street when it reported its fourth quarter earnings on Feb. 5, 2012. The bottom line of $0.77 per share remained $0.12 per share ahead of the consensus mean estimate. This is a positive surprise of 18.5%, which was 16.6% better than the prior year’s bottom line. Compared to the linked quarter, the company's fourth quarter EPS advanced 7%. Higher allocation to credit assets remained the company’s top priority during the fourth quarter, which is why Invesco maintained a stable dividend through 2012.
During the fourth quarter the interest income of $145.4 million surged 3.5% sequentially, largely due to a hike in interest yielding assets. At the same time, the interest expense of $65.1 million climbed 8%, despite a 2 basis points decline in the hedged cost of funds. Other income of $23.2 million advanced around 40% over the prior quarter due to gain on sale of investments, while operating expenses of $10.2 million edged up 2% over the same time period due to management fee, partially offset by a decline in general and administrative expenses. As a result, Invesco Mortgage Capital was able to report a net income of $93.3 million, up 7.5% from the third quarter of the prior year.
Figure 1 shows the percentage of each type of asset and the extent of diversification the company has in its asset portfolio at the end of the fourth quarter of the prior year. It is evident that around 69% of the assets are composed up of Agency residential mortgage backed securities, followed by non-Agency RMBS at 17 and commercial MBS at 11%. Agency collateralized mortgage obligations are 3% of the fourth quarter’s entire asset portfolio.
Within the Agency residential mortgage backed securities one can see further diversification. Figure 2 shows that 30-year fixed rate MBS dominate within the Agency RMBS as it holds around 78% of the Agency RMBS, followed by 15-year fixed rate securities at 17%.
The Agency RMBS have a net weighted average coupon of 4.13%, while Agency CMOs have a coupon of 2.89%. The net weighted average coupon of non-Agency RMBS have a coupon of 4.2% and Commercial MBS have the highest coupon of 5.27%.
In comparison, at the end of the third quarter, MITT reported 4% weighted average coupon for its overall MBS holdings, compared to the weighted average coupon of 4.1%, 3.86%, and 3.54% for American Capital Agency, Annaly Capital Management, and Armour Residential, respectively.
Asset Yield, Interest Expense & Net Interest Income
Since Commercial MBS have the highest coupon, they are the highest yielding assets, with a period end weighted average yield of 4.96%, followed by Non-Agency RMBS offering 4.61%. Agency MBS and Agency CMO offer yields of 2.77% and 2.35%, respectively. Therefore, the total weighted average asset yield comes out to be 3.27%. It is worth mentioning here that the asset yield declined only 2 basis points over the linked quarter. The decline in net asset yield is blamed to the ultra low interest rate environment, partially offset by a hike in CMBS and non-Agency RMBS average balances.
The company seems to have benefited from the ultra low interest rate environment as far as its hedged cost of funds is concerned. The fourth quarter average cost of funds slipped 2 basis points from 1.67% to 1.65%. Non-Agency RMBS remained the largest contributor in the cost of funds, followed by Commercial MBS. The unhedged cost of funds increased 10 basis points from 68 basis points at the end of the third quarter to 78 basis points at the end of the fourth quarter. Much of the rise in unhedged cost was a result of hike in the cost of Agency RMBS.
At the end of the fourth quarter, Invesco Mortgage Capital reported an overall prepayment speed of 14.6% for its entire asset portfolio, compared to 14.3% at the end of the third quarter. The surge in the overall prepayment speeds was associated to accelerated prepayments on Invesco’s Non-Agency RMBS and 15-year fixed rate RMBS, partially offset by a decline in 30-year fixed rate RMBS.
The quarter end debt to equity ratio of 6.1 times declined from 6.4 times at the end of the linked quarter. To trim down its counterparty risk, Invesco has contracts with 29 counterparties which provide it with the required short term financing. In comparison, Armour Residential has 26 counterparties to diversify its risk. The debt to equity ratio of Invesco is similar to Annaly Capital Management’s ratio of 6 times.
I am bullish on Invesco Mortgage Capital due to the very well-diversified nature of asset portfolio it holds under the given macroeconomic environment. The earnings season is on and Invesco Mortgage Capital happens to be the first widely followed mortgage REIT to have reported its fourth quarter performance. Investors of the aforementioned competitors can benefit from the trends visible in Invesco Mortgage Capital’s performance. While investors of Annaly Capital can expect a rise in prepayments, I believe Armour Residential cannot hide from an acceleration in prepayments. ARR has large chunks of 15-year fixed rate securities on which Invesco reported increased prepayments. Furthermore, I believe American Capital Agency, Annaly Capital Management, and Armour Residential are expected to report a drop in their net interest rate spread. However, AG Mortgage Investment Trust’s net interest spread is not expected to take a significant dip as it has a very well diversified asset portfolio consisting of the high yielding commercial MBS and non-Agency RMBS from which Invesco benefitted during the fourth quarter.
equityfinancials has no position in any stocks mentioned. The Motley Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!