Scott Kennedy’s mREIT Earnings Series: Assessing Invesco Mortgage Capital’s Performance For Q4 2023
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Related to the stocks in this article:
CWMF is long: RITM-D, GPMT-A, DX-C, EFC-A, RITM-C, EFC-B, PMT-C, AGNCP, CIM-D, RITM-B, RITM, SLRC, GPMT, RC.
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The rest of this post is from Scott Kennedy.
Summary
This 19th earnings assessment article reviews IVR’s BV and core earnings performance during Q4 2023.
IVR’s BV matched my/our expectations while its core earnings was a notable underperformance.
When broken out, there was some BV outperformance strictly within IVR’s valuation fluctuations and some BV underperformance within the company’s earnings.
While management made 2 mistakes during the quarter (1 anticipated, 1 not anticipated), I/we already had IVR priced at the largest discount in the agency mREIT sub-sector.
As such, no change in IVR’s percentage recommendation ranges or risk/performance rating. IVR is currently deemed appropriately valued (HOLD).
Introduction:
Hi subscribers. For new members, my name is Scott Kennedy and currently I fully cover 20 mortgage real estate investment trust (mREIT) and 15 business development company (“BDC”) common stocks within this Investing Group regarding research/data, subscriber questions, weekly projected book values/net asset values (BV/NAV), and common stock recommendation ranges. Colorado (“CO”) Wealth Management handles the mREIT preferred stocks and he and his team handles all other applicable REIT sectors outside the mREIT sector. CO also provides some mREIT common stock and BDC articles from time-to-time which are more of an “overview/introduction” discussion; typically based either on my or our combined research/data. This also includes some macroeconomic trends and data. My name is always attached to all Investing Group articles I personally wrote so there is no confusion for subscribers.
This REIT Forum article is part of a series of articles over a span of 6-7 weeks which will analyze my previously projected BV/NAV and core earnings (or core earnings equivalent)/net investment income (“NII”) figures and compare these metrics to each mREIT’s and BDC’s actual reported results, respectively. For readers who are familiar with my public mREIT and/or BDC articles, these types of articles are beneficial to readers who desire to pursue a more active investing strategy and/or want more “real time” thoughts/analysis.
I hope my services/contributions ultimately help enhance a subscriber’s total investment returns or minimize their total investment losses within the mREIT and BDC sectors. At the very least, I hope subscribers will gain more insight into the mREIT and BDC sectors by reading my/our exclusive REIT Forum articles.
1) IVR’s BV and Core Earnings Q4 2023 Performance (Projected Versus Actual Results):
On 2/22/2024, Invesco Mortgage Capital Inc. IVR 0.00%↑ reported the company’s earnings results for the fourth quarter of 2023. Table 1 below provides IVR’s BV and earnings summary.
Table 1 – IVR Q4 2023 BV and Earnings Summary
Source: Taken Directly from the REIT Forum’s © Analytical Spreadsheets/Data
I provided the following commentary in regards to IVR’s results for the fourth quarter of 2023:
“Hi subscribers. I was able to review IVR's Q4 2023 earnings results in more depth. IVR reported a BV as of 12/31/2023 of $10.00 per common share (0.7% increase) versus my prior projection of $10.05 per common share (1.2% increase). I consider this basically an exact match (at or within a 0.5% variance) and was well within my $9.55 - $10.55 per common share range.
I would point out the extreme volatility, especially for the agency mREIT model, during the fourth quarter of 2023. BVs notably decreased during September 2023 (some peers in excess of 15%) which quickly “reversed course” during November - December 2023. In my personal opinion, any quarterly BV variance at or within 4% this particular quarter should really be considered an accurate estimate (larger “cone” per se). In addition, as a reminder, the current subscriber spreadsheets are based on CURRENT BVs. For example, currently each company’s BV estimate as of 2/16/2024. In this note, I am comparing 12/31/2023 BV projections versus actual results. Something to mention for newer subscribers. Simply put, an extremely accurate IVR BV projection based on the extreme volatility during the quarter. That said, when broken out, there was some BV outperformance strictly within IVR’s valuation fluctuations and some BV underperformance within the company’s earnings. Let us discuss how IVR’s overall BV basically matched my expectations during the fourth quarter of 2023.
First, similar to a couple other agency mREIT sub-sector peers who underperformed during the quarter (less enhanced BV gains), IVR “panicked” per se during October 2023 and quickly reduced the company’s fixed-rate agency mortgage-backed securities (“MBS”) sub-portfolio as pricing continued to quickly decline (and spread/basis risk remained very high). This was something I correctly accounted for as management previously disclosed this specific strategy. However, as noted in other sub-sector earnings notes, MBS pricing quickly “reversed course” and notably increased during November – December 2023. As such, since IVR sold a portion of the company’s fixed-rate agency MBS sub-portfolio at or near intra-quarter lows, this mREIT lost out on some of the “upside” of BV gains by having a smaller fixed-rate agency MBS sub-portfolio size the remainder of the quarter. In fact, IVR actually increased the company’s fixed-rate agency MBS sub-portfolio later in the quarter when MBS pricing was notably higher. This simply was a mistake on management’s part (though, again, was correctly anticipated).
As of 9/30/2023, IVR’s investment portfolio, which basically solely consisted of fixed-rate agency MBS, had a fair market value (“FMV”) of $5.4 billion. As of 12/31/2023, IVR’s investment portfolio had a FMV of $5.0 billion. When calculated, this was a quarterly decrease in investment portfolio size of ($0.4) billion or (7%). However, I would point as of 10/31/2023, IVR’s investment portfolio size was only $3.6 billion. When calculated, this was an intra-quarter decrease as large as ($1.8) billion or (30%). In comparison, I projected a quarterly decrease of (12.5%) – (7.5%) (mean decrease of (10%)). So, a pretty accurate projection regarding the net change in quarterly investment portfolio size (very large intra-quarter decrease which was lessened by the end of the quarter). IVR reported an on-balance sheet investment portfolio net valuation gain of $165 million during the fourth quarter of 2023. In comparison, I projected an on-balance sheet investment portfolio net valuation gain of $160 million. When calculated, this $5 million variance directly led to a BV outperformance of $0.12 per common share when compared to my expectations.
Second, as IVR changed the underlying composition of the company’s investment portfolio, management also notably altered the composition of its interest rate payer and receiver swaps. While these changes directly led to some BV outperformance when compared to my expectations, this dreadfully altered IVR’s earnings during the quarter via a notable decrease in current period hedging income (discussed in a bit). While lowering IVR’s net (short) interest rate payer swaps position was not too much of a surprise, the underlying compositional changes that occurred within this sub-portfolio was a larger surprise. IVR reported a derivatives sub-portfolio net valuation loss of ($142) million during the fourth quarter of 2023. In comparison, I projected a derivatives sub-portfolio net valuation loss of ($155) million. When calculated, this $13 million variance directly led to a BV outperformance of $0.26 per common share when compared to my expectations.
When both variances noted above are combined, along with a core earnings/EAD underperformance of ($0.454) per common share (which is discussed next) and an outperformance of $0.01 per common share in direct relation to slightly more accretive repurchases of preferred stock, this fully reconciles to the company’s BV underperformance of ($0.05) per common share (rounded) during the fourth quarter of 2023 when compared to my expectations.
Moving on, IVR’s core earnings/earnings available for distribution (“EAD”) of $0.946 per common share for the fourth quarter of 2023 was a notable underperformance versus my prior projection of $1.400 per common share. IVR’s core earnings/EAD was $1.512 per common share for the third quarter of 2023. As such, I projected a core earnings/EAD decrease of ($0.112) per common share. In actuality, IVR reported a core earnings/EAD decrease of ($0.566) per common share. The institutional analysts’ consensus average was core earnings/EAD of $1.174 per common share. Let us reconcile this notable core earnings/EAD underperformance.
First, as mentioned earlier, IVR’s investment portfolio size was pretty similar when compared to my expectations. If anything, IVR’s weighted average cost of funds rate was slightly higher when compared to my expectations while the company’s portfolio yield was slightly lower when compared to my expectations. IVR reported net interest income of $8.3 million during the fourth quarter of 2023. In comparison, I projected net interest income of $9.0 million. When calculated, this ($0.7) million variance directly led to a core earnings/EAD underperformance of only ($0.014) per common share when compared to my expectations. Clearly, this was not the cause of IVR’s notable core earnings/EAD variance.
Second, and most importantly, as noted earlier IVR notably changed the underlying composition of the company’s interest rate payer and receiver swaps. IVR completely exited/terminated the company’s interest rate receiver swaps during the fourth quarter of 2023. In addition, IVR terminated/exiting some very attractive interest rate payer swaps during the quarter which were contributing a good deal of current period hedging income to the company’s core earnings/EAD. In addition, later in the quarter, IVR then added back some short-term interest rate payer swaps at notably less attractive pay rates. Simply put, some very questionable moves were made within IVR’s interest rate swaps sub-portfolio during the fourth quarter of 2023. I believe another mistake. While basically all other sub-sector peers reported relatively unchanged current period hedging income during the fourth quarter of 2023 (which is what management would have reported if they simply kept the company’s swaps sub-portfolio the same/relatively the same), IVR reported a notable decrease in current period hedging income. For example, IVR reported net periodic interest income on interest rate swaps (both payer and receiver) of $72 and $49 million during the third and fourth quarter of 2023, respectively. When calculated, this was a decrease of ($23) million or (32%) which should be considered an extremely large quarterly decrease; considering IVR previously utilized both interest rate payer and receiver swaps. In comparison, I projected IVR would report net periodic interest income on interest rates swaps of $70 million during the fourth quarter of 2023 (which was still a minor quarterly decrease). When calculated, this ($21) million variance directly led to a core earnings/EAD underperformance of ($0.434) per common share when compared to my expectations.
When the 2 variances noted above are combined, along with no net dollar roll (“NDR”) income variance (correctly anticipated no “to-be-announced” [TBA] MBS throughout the quarter) and a total operational expenses underperformance of ($0.006) per common share, this fully reconciles to IVR’s core earnings underperformance of ($0.454) per common share when compared to my expectations.
So, all-in-all, basically an exact match on IVR’s BV (variance of only 0.5%) and a notable underperformance on the company’s core earnings/EAD (variance of $0.454 per common share). While I believe management made a couple mistakes during the quarter (1 anticipated, 1 not anticipated), I would point out I/we already had (and currently have) IVR priced at a discount to basically all agency mREIT sub-sector peers. I continue to believe this discount is appropriate (relative to CURRENT BV) when compared to the better-run, over the long-term, mREIT sub-sector peers. One also has to consider IVR’s notable dividend reduction from $0.65 per common share to $0.40 per common share starting in the first quarter of 2023.
I would also point out, during the trailing 24-months, IVR has continued to suffer the most severe decrease in both BV and economic return (loss) (change in BV and dividends received) out of the 20 mREIT peers I/we currently cover. This is not a good distinction/trend to have. During the trailing 24-months, IVR reported an economic loss of (50.4%). In comparison, the next worst agency mREIT sub-sector peer, ORC, had a trailing 24-month economic loss of (38.4%), respectively. In a more notable sub-sector peer comparison, DX had a trailing 24-month economic loss of only (8.7%). That is a notable difference in performance which, again, includes dividends received. This even factors in IVR’s very strong core earnings performance during 2022 – third quarter of 2023 (which positively impacts BV). IVR’s trailing 24-month notable BV and economic loss underperformance (“bottom of the barrel” out of the 20 mREIT covered stocks) only solidifies why I/we had (and currently have) a risk/performance rating of 4.5 assigned to this fixed-rate agency mREIT peer. This is tied as being the worst risk/performance rating within the agency mREIT sub-sector. BV losses, especially on disposed/sold investments, directly equates to a permanent loss of shareholder value.
When taking IVR’s recent and projected performance into consideration, along with macroeconomic trends/events (mainly Fed monetary policy, the general projected movement of rates/yields, and projected economic performance over the foreseeable future), no change to my/our IVR percentage recommendation ranges (relative to CURRENT BV) or risk/performance rating (remains at a 4.5). Outside already being priced at a discount to peers, I/we did not perform an IVR downgrade this quarter due to the fact, even with the notable quarterly core earnings/EAD decrease, this metric is still well above the company’s current dividend rate of $0.40 per common share.
At a closing price as of 2/23/2024 of $8.62 per share, IVR is deemed to be APPROPRIATELY VALUED/a HOLD recommendation (price target of $8.95 per share). Currently, IVR is not the most overvalued mREIT stock that I/we cover but, in my opinion, is not one of the most undervalued either. I would continue to look for a mREIT sector/sub-sector peer who currently has a more attractive valuation and one who has a more attractive risk/performance rating…”