Invesco Mortgage Capital (IVR) - 2022 Q4 - Annual Report

Part I Business Invesco Mortgage Capital Inc. is an externally managed REIT investing in mortgage-backed securities, focused on stockholder returns and regulatory compliance - The company is externally managed by Invesco Advisers, Inc., which provides its management team and officers as the company has no employees[19][21] - The company maintains its REIT tax status by distributing at least 90% of taxable income and operates to maintain its 1940 Act exclusion[20] Primary Target Assets as of December 31, 2022 | Asset Class | Description | | :--- | :--- | | Agency RMBS | Residential mortgage-backed securities guaranteed by Ginnie Mae, Fannie Mae, or Freddie Mac. | | Non-Agency CMBS | Commercial mortgage-backed securities not guaranteed by a U.S. government agency. | | Non-Agency RMBS | Residential mortgage-backed securities not guaranteed by a U.S. government agency. | | TBAs | To-be-announced securities forward contracts to purchase Agency RMBS. | | Other | Other real estate-related financing arrangements. | - The company's financing strategy primarily relies on short-term repurchase agreements (1-6 months) to finance its target assets[50] - Risk management is integral, actively managing market, credit, liquidity, and foreign exchange risks through hedging with derivative instruments[56][57][60][63] Risk Factors The company faces material risks across business, investment, financing, hedging, company-specific, and tax categories, impacting operations and financial stability Risks Related to Our Business and Investments Business and investment risks include economic conditions, Federal Reserve actions impacting Agency RMBS, interest rate fluctuations, spread risk, and intense competition for assets - The U.S. Federal Reserve's actions in the Agency RMBS market, including balance sheet contraction, can materially impact supply, price, and returns, potentially lowering valuations[79][80] - Interest rate fluctuations pose risks, as rising rates increase borrowing costs, and an inverted yield curve can decrease net income; the FOMC increased rates by 425 basis points in 2022[84][85][86] - Changes in mortgage prepayment rates can adversely affect profitability, with faster prepayments on premium securities accelerating premium expense and reducing income[94][95] - The company operates in a highly competitive market, limiting its ability to acquire target assets at attractive prices due to competition from other REITs and financial institutions[105] Risks Related to Financing and Hedging Financing and hedging risks include amplified losses from leverage, heavy reliance on short-term repurchase agreements, exposure to margin calls, and the potential for imperfect or costly hedging strategies - The use of leverage may adversely affect returns, reduce cash for distributions, and increase losses during unfavorable economic conditions[130][132] - The company depends heavily on repurchase agreement financing, which can be impacted by market disruptions leading to tighter lending standards, increased costs, and reduced liquidity[133][134] - Financing arrangements expose the company to margin calls, potentially forcing asset sales at depressed prices if pledged asset values decline[137] - Hedging activities may fail to protect earnings due to high costs, imperfect correlation, duration mismatches, and counterparty default risk[143] Risks Related to Our Company and Manager Company and manager risks include limitations from the 1940 Act exclusion, high dependence on the external manager and key personnel, potential conflicts of interest, and costly termination provisions in the management agreement - Maintaining 1940 Act exclusion imposes significant operational limits, requiring at least 55% of assets to be qualifying real estate assets, thus limiting investment flexibility[156][157] - The company is completely reliant on its external Manager and key personnel for all operations and investment decisions, with their departure potentially harming performance[168] - Conflicts of interest exist as the Manager and its affiliates manage competing funds, potentially allocating favorable investment opportunities to other clients[169][171] - Termination of the management agreement without cause is difficult and costly, requiring a payment of three times the average annual management fee over the prior 24-month period[174] Tax Risks Tax risks primarily involve the potential failure to qualify as a REIT, which would result in corporate income tax and reduced distributions, alongside complex ongoing compliance and potential IRS challenges to instrument tax treatment - Failure to qualify as a REIT would subject the company to U.S. federal income tax, reducing cash for distributions, and preventing re-election of REIT status for five years[192][194] - The REIT distribution requirement (at least 90% of taxable income) could force asset liquidation, unfavorable borrowing, or taxable stock distributions, hindering growth[200][202] - The IRS could challenge the characterization of repurchase agreements as secured borrowings; if treated as sales, the company could fail REIT qualification[208] - The tax treatment of To-Be-Announced (TBA) securities for REIT tests is based on counsel's opinion and is not binding on the IRS; a challenge could jeopardize REIT status[225] Unresolved Staff Comments, Properties, Legal Proceedings, and Mine Safety Disclosures The company reports no unresolved SEC staff comments, no material legal proceedings as of December 31, 2022, and mine safety disclosures are not applicable - The company has no unresolved staff comments[238] - The company was not involved in any material legal proceedings as of December 31, 2022[240] Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock trades on the NYSE, with quarterly dividends intended to maintain REIT status; in 2022, preferred shares were repurchased, and common stock underperformed market indices over five years - The company's common stock trades on the NYSE under "IVR", with quarterly dividends intended to distribute substantially all taxable income[243] 5-Year Cumulative Total Return Comparison | Index | 12/31/2017 | 12/31/2022 | | :--- | :--- | :--- | | Invesco Mortgage Capital Inc. | $100.00 | $14.46 | | S&P 500 | $100.00 | $156.88 | | FTSE NAREIT Mortgage REITs | $100.00 | $81.53 | - As of December 31, 2022, 1,816,398 common shares were available for repurchase, though none were repurchased in Q4 2022[251] - A May 2022 board-approved program allowed repurchase of 1,337,634 Series B and 1,316,470 Series C preferred shares as of December 31, 2022, with no Q4 2022 repurchases[252] Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) In 2022, aggressive Federal Reserve policy led to sharply higher interest rates, causing a 56% decrease in book value and a net loss of $417.0 million for common stockholders, despite portfolio repositioning and derivative gains Market Conditions and Investment Activities In 2022, aggressive Fed rate hikes and the end of RMBS purchases caused severe market underperformance, leading the company to reduce its portfolio from $9.5 billion to $4.8 billion and shift to higher-coupon Agency RMBS - In 2022, the Federal Reserve increased the Federal Funds target rate by 425 basis points, leading to an inverted yield curve, interest rate volatility, and reduced demand for Agency RMBS as net purchases concluded[258] Investment Portfolio Summary ($ in thousands) | Investment Type | Dec 31, 2022 | Dec 31, 2021 | | :--- | :--- | :--- | | Agency RMBS | $4,746,693 | $7,732,280 | | Non-Agency CMBS | $36,787 | $62,909 | | Non-Agency RMBS | $8,413 | $9,070 | | TBAs (implied cost basis) | $1,437 | $1,636,906 | | Total Investment Portfolio | $4,793,882 | $9,477,156 | - The company significantly shifted its Agency RMBS portfolio from 2.0%-3.5% coupons at year-end 2021 to 4.5%-5.5% coupons by year-end 2022[266] Results of Operations In 2022, the company reported a net loss of $402.9 million and a net loss attributable to common stockholders of $417.0 million, driven by $1.1 billion in investment losses partially offset by $559.0 million in derivative gains Consolidated Results of Operations Summary ($ in thousands) | Metric | 2022 | 2021 | | :--- | :--- | :--- | | Net Interest Income | $142,953 | $180,492 | | Gain (loss) on investments, net | ($1,079,339) | ($366,509) | | Gain (loss) on derivative instruments, net | $559,007 | $122,611 | | Net Income (Loss) | ($402,924) | ($90,000) | | Net Income (Loss) Attributable to Common Stockholders | ($416,963) | ($132,477) | | Basic EPS | ($12.21) | ($4.82) | - Book value per common share decreased by 56% in 2022, from $29.09 to $12.79, primarily due to interest rate volatility impacting Agency RMBS valuations[284] - A one-for-ten reverse stock split was effected on June 3, 2022, with all per-share amounts retroactively adjusted[282] Non-GAAP Financial Measures The company uses non-GAAP measures like EAD and Economic Debt-to-Equity Ratio; in 2022, EAD increased to $185.0 million, and the economic debt-to-equity ratio decreased to 5.3x Reconciliation to Earnings Available for Distribution (EAD) | $ in thousands, except per share data | 2022 | 2021 | | :--- | :--- | :--- | | Net income (loss) attributable to common stockholders | ($416,963) | ($132,477) | | Adjustments (net) | $601,974 | $246,152 | | Earnings available for distribution | $185,011 | $113,675 | | EAD per common share | $5.42 | $4.13 | Economic Debt-to-Equity Ratio | As of | Repurchase Agreements ($M) | TBAs at Implied Cost Basis ($M) | Total Stockholders' Equity ($M) | Economic Debt-to-Equity Ratio | | :--- | :--- | :--- | :--- | :--- | | Dec 31, 2022 | $4,234.8 | $1.4 | $804.1 | 5.3x | | Dec 31, 2021 | $6,987.8 | $1,636.9 | $1,402.1 | 6.2x | Liquidity and Capital Resources The company's liquidity sources include equity offerings, operations, and repurchase agreements; as of December 31, 2022, it held $278.8 million in cash and $352.9 million in unencumbered investments, with an average 4.6% haircut on Agency RMBS repurchase agreements - As of December 31, 2022, the company held $278.8 million in cash and restricted cash, plus approximately $352.9 million in unencumbered investments for liquidity[396][408] - The average margin requirement, or "haircut," on Agency RMBS repurchase agreements was 4.6% as of December 31, 2022[403] - As of December 31, 2022, the company had 17 repurchase agreement counterparties, with no single counterparty holding collateral exceeding $40.2 million or 5% of stockholders' equity above borrowed amounts[416] Quantitative and Qualitative Disclosures about Market Risk The company's primary market risks include interest rate, spread, prepayment, and credit risks, managed through asset selection, leverage, and derivatives; a 100 basis point rate increase would decrease portfolio value by 1.15% and net interest income by 2.97% Interest Rate Sensitivity Analysis (as of Dec 31, 2022) | Change in Interest Rates | Percentage Change in Projected Net Interest Income | Percentage Change in Projected Portfolio Value | | :--- | :--- | :--- | | +1.00% | (2.97)% | (1.15)% | | +0.50% | (1.54)% | (0.48)% | | -0.50% | 1.56 % | 0.22 % | | -1.00% | 2.90 % | 0.13 % | - The company's primary market risks include interest rate, spread, prepayment, extension, and credit risks on its mortgage investments[421][429][431][433] - The company manages risk by monitoring financing agreements, using hedging instruments like interest rate swaps, and actively managing asset and liability interest rate characteristics[446] Controls and Procedures Management concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2022, with the independent auditor issuing an unqualified opinion - Management concluded that the company's disclosure controls and procedures were effective as of December 31, 2022[448] - Based on the COSO framework, management concluded that internal control over financial reporting was effective as of December 31, 2022[451] - PricewaterhouseCoopers LLP issued an unqualified opinion on the effectiveness of the company's internal control over financial reporting as of December 31, 2022[452] Part III Directors, Executive Compensation, and Other Matters Information for Items 10 through 14, covering directors, executive compensation, security ownership, related transactions, and accounting fees, is incorporated by reference from the forthcoming 2023 proxy statement - Information for Items 10-14 (Directors, Executive Compensation, Security Ownership, Related Transactions, and Accounting Fees) is incorporated by reference from the forthcoming proxy statement[458][460][461][462] Part IV Exhibits and Financial Statement Schedules This section includes the audited consolidated financial statements for 2022, with PricewaterhouseCoopers LLP issuing an unqualified opinion on financials and internal controls, identifying MBS valuation as a critical audit matter - PricewaterhouseCoopers LLP issued an unqualified opinion on the consolidated financial statements and internal control over financial reporting as of December 31, 2022[481] - The auditor identified the valuation of mortgage-backed securities ($4.8 billion) as a critical audit matter due to the high degree of effort and judgment required for fair value evaluation[488][489] Consolidated Balance Sheet Highlights ($ in thousands) | Account | Dec 31, 2022 | Dec 31, 2021 | | :--- | :--- | :--- | | Total Assets | $5,097,395 | $8,443,841 | | Total Liabilities | $4,293,320 | $7,041,706 | | Total Stockholders' Equity | $804,075 | $1,402,135 | Key Stockholders' Equity Events in 2022 | Event | Details | | :--- | :--- | | Reverse Stock Split | A one-for-ten reverse split of common stock was effected on June 3, 2022. | | Preferred Stock Repurchase | Repurchased and retired 1,662,366 shares of Series B and 3,683,530 shares of Series C preferred stock, resulting in a $14.2 million gain. | | Common Stock Issuance | Sold 5,686,598 shares of common stock via at-the-market offerings for net proceeds of $81.6 million. | | Dividends Declared (Common) | Declared total dividends of $3.10 per share on common stock. |