Last year was a horrible time for the mortgage real estate investment trust (REIT) sector. Early on in the COVID-19 crisis, mortgage markets seized up and triggered a selling vortex for many mortgage-backed securities. Even mortgage bonds that were guaranteed by the U.S. government were thrown overboard until the Fed began to support the market.
Eventually, the crisis passed. However, several names in the space almost didn't make it through. One such name, Invesco Mortgage Capital (NYSE:IVR), went on a wild ride and became a favorite of the Robinhood crowd. Now that the financial markets' stress from early 2020 has abated, would this stock make sense in your portfolio?
Mortgage REITs have an unusual business model
Mortgage REITs are quite different than the typical REIT. Most real estate investment trusts follow the landlord/tenant business model. These companies develop real estate properties such as shopping malls, office buildings, or apartments and then lease the properties to tenants. It is an easy-to-understand business model. Mortgage REITs don't own properties or charge rent; they buy mortgage debt (i.e., mortgage-backed securities and other real estate financial investments). These companies use leverage to magnify the returns on the mortgage-backed securities. This leverage became a problem early in 2020.
The use of leverage magnifies returns, which is a good thing in rising markets, and a major problem when things start falling apart. While most of Invesco's portfolio was in government-guaranteed mortgages at the beginning of 2020, this was little help when the mortgage market hit an air pocket early in the COVID-19 crisis. As the value of Invesco's portfolio fell, the company's creditor banks made margin calls, which are demands that the company put up more cash collateral against its mortgage portfolio. Invesco was unable to come up with the cash and was forced to try and sell illiquid assets in a falling market. It was a disaster. Invesco eventually reached a forbearance deal with its creditors, which gave the company time to shrink its asset portfolio in a more orderly manner. Invesco cut its dividend, sold off assets, and eventually exited forbearance this summer.
The pre-pandemic chart is irrelevant
Below is a chart of the company's stock price. You can see how much this company was beaten up last spring.
The most important takeaway from this chart is that the pre-pandemic prices are completely irrelevant now. This isn't a tech stock that can recover lost ground quickly. Mortgage REITs trade right around book value, and book value increases slowly over time. While many of the assets that made up Invesco's pre-crisis portfolio have returned to pre-crisis levels, Invesco no longer holds them. It sold them during the crisis. Invesco entered 2020 with $22.3 billion in assets. As of Sept. 30, it held $6.5 billion, a decline of 70%.
While the stock is a shadow of its former self, that doesn't automatically make it a lousy investment. The current $0.08 quarterly dividend gives the stock a yield of 9.6%. As of Sept. 30, 93% of Invesco's assets were still in mortgage-backed securities guaranteed by the U.S. government. The stock had a book value of $3.47 per share at the end of September, so at current levels it is trading with a 3.5% discount to book. At this point, Invesco might make sense for income investors who are attracted to the 9.6% yield. That said, more established agency REITs like Annaly Capital Management and AGNC Investment Corp. have similar yields and valuations and managed to make it through the crisis without a near-death experience. While Invesco is a decent hold at these levels, Annaly and AGNC are safer, in my opinion.