Invesco Mortgage Capital (NYSE: IVR) is a mortgage REIT with a portfolio that consists of commercial and residential mortgage-backed securities, among other assets. With the stock still trading for significantly less than its pre-2020 value and a dividend yield of nearly 10%, it might look like an attractive bargain at first glance.
In this article, we'll take a closer look at how Invesco Mortgage Capital makes its money, why its stock price has fallen so sharply over the past year, and whether it might be worth a look for investors now.
Invesco Mortgage Capital Company Profile
Invesco Mortgage Capital is a real estate investment trust, or REIT. Instead of owning physical real estate, however, the company is a mortgage REIT, focusing its investment efforts on residential and commercial mortgages and mortgage-backed securities.
Invesco Mortgage Capital went public in 2009 and is managed by a subsidiary of Invesco (NYSE: IVZ), a massive investment management firm. (If you're familiar with the Nasdaq ETF that trades under ticker symbol QQQ, that's an Invesco product.)
The bulk of Invesco Mortgage Capital's portfolio consists of agency residential mortgage-backed securities (agency RMBSs). In other words, Invesco owns mortgages that meet the lending standards of government-sponsored enterprises like Fannie Mae and Freddie Mac. In addition, the company owns a substantial portfolio of non-agency commercial mortgage-backed securities (CMBSs) as well as smaller amounts of non-agency RMBSs, commercial loans, and other investments.
Mortgage REITs 101
If you aren't familiar, the general business model of a mortgage REIT is to borrow money on a short-term basis (at a relatively low interest rate) and purchase mortgages that pay higher interest rates. For example, if a mortgage REIT can borrow money at 1% interest to buy mortgages paying 3%, the 2% difference is the profit.
Because no investor would be happy with a 2% return, mortgage REITs use quite a bit of leverage to achieve much higher profits. At the end of the third quarter, Invesco Mortgage Capital had a debt-to-equity (leverage) ratio of 4.3-to-1, meaning that for every $100 in assets, the company borrowed $430 to help fund its investments.
The problem with this business model is that it's very rate-sensitive. When rates spike higher, short-term borrowing costs get much more expensive, and profit margins can quickly disappear. And when rates rapidly move lower, there's often a wave of mortgage refinancings, and loans get prepaid (and therefore don't produce any further income for the mortgage REIT).
In reality, the business isn't that simple. For example, mortgage REITs use hedging strategies like interest rate swaps to protect against rapid interest rate fluctuations. But the general idea is that these are rate-sensitive businesses and when borrowing rates spike in either direction, it can cause significant turbulence for these companies.
Invesco Mortgage Capital news
I won't sugarcoat it. Invesco Mortgage Capital was hit hard by the COVID-19 pandemic, which is by far the most significant news item to ever affect the company.
In March when the pandemic hit, interest rates were all over the place. According to the company's March 24, 2020, press release: