An attractive dividend provider is a hold at the moment
Stock: Invesco Mortgage Capital (ticker IVR)
The Maryland-incorporated REIT focused on residential and commercial mortgage-backed securities and mortgage loans recently declared a 2.5% increase in its dividend. Initially, this could be just easily taken for granted, but at 9.4% dividend yield, 0.9 PB ratio, and a mouth-watering 3.7 PE ratio should appeal to even the most conservative investors.
These valuations were not always these consistent and historical annual losses have indicated that the current attractive valuations may not hold or maybe even irrelevant. So it could be more rational to simply assess Invesco’s balance sheet.
As of June, Invesco had $64 million in cash and cash equivalents, and $2.05 billion in long-term debt with debt-equity ratio 0.8 times compared to 0.93 times a year earlier. Overall long-term debt rose $178 million while equity shrunk by $130 million to $2.2 billion.
In addition, Invesco carries no goodwill nor intangibles in its assets but $16.08 billion (96.5%) of its assets in mortgage-backed and credit risk transfer securities. These assets vary in figure in recent years as it had shown a decline of 4.7% in total in the past three years.
Invesco Mortgage Capital
According to filings, Invesco Mortgage Capital is externally managed and advised by Invesco Advisers, Inc., its Manager, a registered investment adviser and an indirect, wholly-owned subsidiary of Invesco Ltd., a leading independent global investment management firm.
Further, Invesco Mortgage’s objective is to provide attractive risk-adjusted returns to its investors, primarily through dividends and secondarily through capital appreciation. Its objective, the company primarily invests in the following:
Agency RMBS (41% of Invesco Mortgage equity)
-Residential mortgage-backed securities that are guaranteed by a U.S. government agency such as the Government National Mortgage Association or a federally chartered corporation such as the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation (Agency RMBS).
Commercial Credit (2; 33% of equity)
-RMBS that are not guaranteed by a U.S. government agency (non-Agency RMBS).
-Credit risk transfer securities that are unsecured obligations issued by government-sponsored enterprises (GSE CRT).
Residential Credit (3; 26% of equity)
-Commercial mortgage-backed securities (CMBS).
-Residential and commercial mortgage loans
-Other real estate-related financing arrangements.
What is more attractive is that Invesco Mortgage has elected to be taxed as a real estate investment trust (REIT) for U.S. federal income tax purposes under the provisions of the Internal Revenue Code of 1986. To maintain its REIT qualification, the company is generally required to distribute at least 90% of its REIT taxable income to its stockholders annually.
As per filings, the company conducts its business through an IAS Operating Partnership LP (the Operating Partnership), as its sole general partner.
As of June 30, 2017, the REIT owned 98.7% of the Operating Partnership, and a wholly-owned subsidiary of Invesco owned the remaining 1.3%. Invesco Mortgage also has one operating segment.
Invesco Mortgage’s operating results can be affected by a number of factors and primarily depend on the level of our net interest income and the market value of its assets.
Net interest income
The company’s 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 the company’s 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.
Meanwhile, the market value of Invesco Mortgage’s assets can be impacted by credit spread premiums (yield advantage over U.S. Treasury notes) and the supply of, and demand for, target assets in which the company invests.
In the first half, Invesco Mortgage’s net interest income rose 8.3% year over year to $169.2 million brought mostly by an 8% decline in interest expenses and a 2.3% rise in interest income. Net interest margin, meanwhile, was at 1.94% compared to 1.85% a year earlier.
Book value
Invesco Mortgage calculates its book value by deducting preferred shares in its equity divided by all diluted shares outstanding. The company’s book value per share as of June grew 4.5% year over year to $18.27 a share.
Cash flow
In the first half, Invesco Mortgage’s cash flow from operations declined by 4.6% to $154.4 million. In addition, dividends and distributions represented 66% of its cash flow from operations.
The REIT does not have capital expenditures but has allocated net $895.5 million in the urchase of mortgage-backed and credit risk transfer securities for the period and raised $63.2 million in repurchase agreement proceeds.
Repurchase agreements are short- and long-term borrowings made by Invesco Mortgage to finance its investments. Under repurchase agreement financing arrangements, certain buyers require the borrower to provide additional cash collateral in the event the market value of the asset declines to maintain the ratio of value of the collateral to the amount of borrowing.
Conclusion
Invesco Mortgage’s recent half operations, including the company’s net interest income and book value performance, strongly indicated a healthy appreciation of profitability for the company.
It is important to highlight though that the REIT has experienced a slow decline in its overall net interest income in recent years, but interest expenses has shrunk faster therefore leading to a supportive net interest income figures.
Average analysts have an overweight recommendation on Invesco Mortgage with a target price $17.58 a share vs. $17.12 at the time of writing.
In summary, Invesco Mortgage is a hold with $17.5 target.
Quotes
John Anzalone, Chief Executive Officer (second quarter results)
“Our portfolio was well positioned to benefit from market conditions during the second quarter.”
“Our diversified sector allocation and security selection led to favorable economic return performance and continued book value stability. We have maintained a steady dividend of $0.40 per common share for the last eight quarters. Our consistent approach and execution has generated core earnings covering our dividend in seven of those eight quarters.”
Disclosure: I do not have shares in any of the companies mentioned.
Perennial investing by Mark Y. 