Well, that’s not exactly a great excuse, considering that American Capital Agency reported a 3% increase in book value for the same quarter, and AGNC also uses interest rate swaps. Clearly Invesco miscalculated something in its hedging strategy.
Overall, I am bullish on the mREIT sector for the near future. Regarding Invesco, investors should really watch the company's next book value announcement for direction.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The good news for mREITs clearly is the announcement at the latest Fed meeting that interest rates will remain at very low levels (near zero) for at least two years. This should not have been a surprise to anyone – raising rates tangibly in the current dismal macroeconomic conditions would have been practical suicide. But this news is extremely important for the sector since mREITs’ borrowing costs, which are mostly very short-term loans, are in my opinion the most crucial determinant of profitability and growth.
I like Invesco Mortgage (IVR), not because it has the greatest management in the world, but because of its more diversified portfolio, which includes commercial mortgage-backed securities (CMBS) and non-agency backed securities. CMBSs have a higher yield than residential securities. I also like Invesco’s overall interest spread – as of June 30, 2011, the company’s weighted average interest rate on borrowings was 0.52%, while weighted average yield on their entire portfolio was 4.28%. This average yield already includes prepayment and loss assumptions. Well, I really like those numbers and I don’t see them changing much in the next two years. And yes, this beats American Capital’s (AGNC) net interest spread of 2.36% as of the same date.
Secondary Market Offerings
There does seem to be a trend lately towards selling tons of new shares in order to raise capital. So what to make of the seemingly constant secondary market offerings that we’ve seen in 2011 from IVR, AGNC, Hatteras Financial Corp. (HTS), Annaly Capital (NLY), Two Harbors (TWO), MFA Financial (MFA), etc.? Generally speaking, if you have faith in the company’s management this should be viewed as a positive sign, i.e. that it would eventually increase the shareholders’ value. They are seeing opportunities to buy more assets at attractive prices. Of course if you don’t have faith in management then clearly you should not be investing in the company, regardless of what the current yield is.
On the other hand, I am worried about the fast rate of growth of some mREITs. When I realized that the size of Invesco’s portfolio is set to more than double this year, my head started spinning and has not stopped since.
Invesco Mortgage reported its book value per share as of June 30, 2011 at $19.34, compared to $21.24 per share as of March 31, 2011. This represents almost a 9% drop in three months! The company stated, “The decrease in book value was primarily driven by the decrease in the value of our interest rate swaps.”