During its fourth-quarter earnings call, Invesco Mortgage Capital Inc (NYSE:IVR)’s dividend sustainability was seen as a strong positive. However, the latest quarter’s results featured some negative commentary regarding dividend sustainability, and we are going to take a look at what might be wrong.
What’s up at Invesco?
Invesco Mortgage Capital Inc (NYSE:IVR) reported strong first-quarter performance. The company’s reported core EPS of $0.59 trailed the consensus estimate of $0.64 per share. Some of the other key takeaways of the latest financial disclosures include:
Interest income surged 13% to $160.5 million over the prior year. Compared to the last year, interest income increased 10.4% due to an increase in the average interest earning assets.
Net interest income came in at $92.9 million, up 16% from last year, partially due to a 2 bps higher net interest rate spread. The company saw an increase in average earning assets, despite slightly higher interest expense.
As a result, net income of $87.6 million was 6% lower than last year.
Book value per share declined 2% to $20.42 as the company’s interest rate hedges and its non-Agency holdings were not able to offset the losses on its Agency MBS holdings from the first-quarter interest rate sell-off.
Term financing exposure increases, repos exposure decreases
The prevailing challenging times motivated Invesco Mortgage Capital Inc (NYSE:IVR) to diversify its borrowings into term financing. The company issued an exchangeable 5% senior note, and incorporated securitization financing to become less reliant on the repo market. One primary reason for shifting their funding exposure from repos to term financing was to shift their interest rate exposure. However, this is expected to accelerate the contraction of the spread at Invesco Mortgage in the coming quarters.Management also showed its intentions of increasing longer-term financing in order to diversify funding types.
While the company was able to expand its net interest rate spread modestly during the first quarter, the outlook doesn’t seem as promising. I believe, the company’s funding cost will increase as management employs more term financing that carries a higher interest rate. The projected higher cost of funds will have the effect of contracting the net interest rate spread of the company in the second quarter. Therefore, the levered returns could decline implying a dividend cut wouldn’t be too far behind.
Bad news for everyone?
Invesco Mortgage Capital Inc (NYSE:IVR) competes with other mortgage REITs, including Capstead Mortgage (NYSE:CMO) and MFA Financial (NYSE:MFA) . The dividend outlook at one of these companies doesn’t look quite as grim.
Capstead Mortgage paid $34 million in dividends during the first quarter while it generated $63.2 million in operating cash flow. Its cash dividend coverage comes out to be 1.86 times, which is sufficient to cover moderate contractions in the net interest rate spread.
On the other hand, MFA Financial generated $71.1 million in cash from its operations while it paid 71.9 million in dividends during the first quarter of the current year. Its cash dividend coverage ratio comes out to be 0.99 times, which means that the company is already having difficulty covering its dividend rate through its regular operations. Any further compression in its net interest rate spread may result in a dividend cut.