Update (Tuesday, March 24): After we published, Invesco announced it was unable to meet its margin calls and was in forbearance discussions with its lenders. While most of Invesco's assets are "money good" -- i.e. they will be paid in full -- there is a liquidity crunch happening that makes that meaningless. Until the dust settles, the mortgage REITs will be subject to extreme volatility.
The sell-off in the stock market has spared few sectors, and mortgage real estate investment trusts (mREIT) are no exception. One such stock is Invesco Mortgage Capital (NYSE:IVR) which has been crushed.
Does a stock trading at less than half of book value and a currently offering a 37% dividend yield grab your attention? Read on...
2019 results and Invesco's portfolio
Invesco had a solid 2019, raising its dividend by 6% and reporting an increase in book value per share of 6.7% to $16.29. In 2019, Invesco paid $1.85 per share in dividends and declared a first-quarter dividend of $0.5 a share on March 17 (in the midst of the coronavirus sell-off). With Invesco trading at $5.44 a share, this works out to a discount to book value of 67% and a prospective dividend yield of 37%.
Below is a table laying out the assets in the portfolio and any debts against those assets (either repurchase agreements or secured debt). RMBS stands for residential mortgage-backed securities, and CMBS stands for commercial mortgage-backed securities.
|Agency RMBS (government guaranteed)||$11.3 billion||$10.2 billion|
|Agency CMBS (government guaranteed)||$4.8 billion||$4.2 billion|
|Commercial credit||$3.8 billion||$3.2 billion|
|Residential credit||$1.9 billion||$1.6 billion|
|Total||$22.3 billion||$19.4 billion|
Government-guaranteed mortgages comprise most of the portfolio
Invesco Mortgage is a hybrid mortgage real estate investment trust, which means it makes its money by investing in securities and passing the return on to investors. As a hybrid mREIT, Invesco invests in mortgages that are backed by the government and securities that are not. About 74% of Invesco's assets are in agency mortgage-backed securities. These are securities issued by Fannie Mae or Freddie Mac that contain a government guarantee. In other words, if the borrower doesn't pay the mortgage, the government will make sure Invesco still gets the principal and interest it is owed.
The credit-sensitive portfolio is about 26% of assets and is comprised mainly of commercial mortgages secured by office, retail, multifamily, industrial, and multifamily properties. Over half the book is investment grade, and 80% was originated prior to 2017, which means that the value of the underlying collateral is probably much higher than it was when the loan was made. The other portion is comprised of non-agency residential mortgage-backed securities and credit risk transfer securities issued by Fannie Mae and Freddie Mac.
The commercial credit book was marked at 83% of par at the end of the year. Over half the book is investment grade, and these are first- and second-lien loans secured by commercial real estate. The Residential Credit book contains non-agency (not government-guaranteed) mortgage-backed securities and credit risk transfer securities issued by Fannie Mae and Freddie Mac. Roughly 63% of the residential mortgages are prime and 28% are Alt-A rated.
Prepayment risk and interest rate shocks
The big fear for mREITs these days is prepayment risk, which means that these securities could pay off early. When that happens, the mREIT will suffer a loss if it paid over par for the security. Invesco mitigates this risk in a couple of ways. First, it invests in mortgage-backed securities that contain loans with characteristics that make them less likely to prepay. About a third of Invesco's agency book contains loans with prepayment penalties, which limits this behavior.
In its annual report, Invesco modeled out the effect of interest rate shocks. A 1% decrease in interest rates is expected to have a mildly positive effect on the value of the portfolio, although interest income will decline. Yes, it is possible that we could see a massive refinancing wave, which will wipe out big chunks of the portfolio. That said, the agency is currently valued at 102.6% of par. If the entire agency book prepaid tomorrow, the company would lose 2.6%. That works out to be $419 million, or 17% of the company's $2.3 billion book value attributable to common shareholders.
The entire sector is at fire-sale prices
The entire mREIT sector has been thrown overboard since the coronavirus crisis began. At this point, these stocks are at fire-sale prices. While book value per share is probably not $16.29 anymore given that agency prepayment speeds have increased, it hasn't fallen by two-thirds either. Last year, the company earned $2.42 a share. It just declared a quarterly dividend of $0.50 a share. As famed investor and economist Benjamin Graham would put it, at $5.44 a share, there is a huge margin of safety in this stock. This is a value stock, not a value trap.