Buy IVR On Diversified MBS Mix
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Invesco Mortgage Capital (NYSE: IVR) was formed to operate as a debt REIT that invests in residential and commercial mortgage backed securities besides investing in mortgage loans. The residential mortgage backed securities that Invesco is primarily interested in are MBS for which any of the government sponsored Agencies guarantee the interest and principal payment. The company also has non-Agency MBS in its portfolio, which provide the advantage of diversification to Invesco under the prevailing challenging macroeconomic environment.
The graphs above show the percentage of each type of MBS in the company’s investment portfolio at the end of the fourth quarter of 2012. Agency MBS are 69%, while non-Agency MBS constitute 17%. Within the Agency MBS holdings, the company has a large concentration in 30-year fixed rate, followed by 15-year fixed rate securities.
Recent Quarter’s Performance Review
At the end of the fourth quarter, IVR reported interest income of $145.4 million, up 3.5% sequentially. Much of the increase in interest income can be attributed to the surge in interest earning assets, partially offset by a decline in average portfolio yield. During the fourth quarter, average interest earning assets increased 5%, while average interest yield of 3.27% declined 4 basis points over the linked quarter.
During the most recent quarter, Invesco incurred $65.1 million in debt, up 8% sequentially. The surge can be associated to a hike in average borrowed funds during the quarter, partially offset by a decline in the average cost of funds. Average borrowed funds of $15.8 million increased 10% during the quarter, while the cost of funds of 1.65% decreased 2 basis points.
As a result, Invesco posted net interest income of $80.3 million, edging up from $80.2 million at the end of the third quarter of 2012. The company earned 1.62% in net interest spread, down 2 basis points from the net interest spread of the linked quarter.
Other income of $23.2 million grew from the prior quarter’s other income of $16.6 million, while operating expenses of $10.2 million surged 2% over the same time period. As a result, Invesco reported net income of $93.3 million, up 7.5% from the prior quarter.
Invesco Mortgage reported a book value of $20.83 at the end of the fourth quarter, down 0.5% from the linked quarter. In comparison, American Capital Agency (NASDAQ: AGNC)’s book value decreased 2.6%, while Annaly Capital Management (NYSE: NLY) reported a 4.5% decline in its book value at the end of the fourth quarter. Two Harbors (NYSE: TWO) reported a book value of $11.54 per share, up from the linked quarter’s $11.44 per share.
The company reported prepayment speed of 14.6% for its fourth quarter overall MBS portfolio. Agency hybrid ARMs had a 28.5 CPR, while the non-Agency MBS had 17.7% and 30-year Agency MBS had 17.4% CPR. The company’s MBS portfolio reported a CPR of 14.3% at the end of the linked quarter.
In comparison, Two Harbors reported 6.6% CPR for its Agency RMBS, while its non-Agency MBS had 3.2% CPR at the end of the fourth quarter of the current year. CYS reported relatively slow prepayment speeds for its MBS portfolio. The prepayment speeds as represented by conditional prepayment rate for CYS Investments, American Capital Agency and Annaly Capital Management were 17.6%, 10% and 19%, respectively. American Capital and Annaly Capital are exclusively invested in fixed rate mortgage backed securities of varying maturities.
Leverage & Hedges
IVR reported a decline in the quarter end leverage from 6.4 times at the end of the same quarter of the prior year to 6.1 times at the end of the most recent quarter of 2012. TWO reported a decline in its leverage from 3.8 times at the end of the third quarter to 3.4 times at the end of the most recent quarter. AGNC and NLY report 7 times and 6.6 times leverage, respectively, at the end of the most recent quarter.
As of quarter-end IVR had $8.0 billion of swaps, $200 million more than last quarter, which represents 68% of the company’s total agency repos and 51% of total repos. This is compared to 63% and 40% for American Capital Agency and Annaly Capital Management, respectively.
Recent capital raise
Invesco has deployed the capital from its January capital raise consistent with its current equity allocation, as it continues to find attractive opportunities across the mortgage landscape. Management indicated that the recent capital raise was invested at returns accretive to earnings.
I believe the company has a well diversified MBS mix that is well positioned for the current macroeconomic environment. The stock is trading in line with its book value, while it yields 12.18%. Therefore, I recommend investors buy the stock and benefit from its elevated dividend yield.
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