Invesco Mortgage Capital Inc (NYSE:IVR) is a mid-cap mortgage REIT that makes money from capital gains and rent, but also interest. That’s why it’s classified as a hybrid mortgage REIT. It reported stronger than expected EPS for the first quarter and I think the company will report strong results going forward.
Current mix
The company has investments in fixed rate and adjustable rate residential and commercial mortgage backed securities. According to fair values, around 72% of the company’s entire investment portfolio is Agency MBS, 17% are non-Agency RMBS, and 11% are commercial mortgage backed securities or CMBS. The company has a large proportion of 30-year fixed rate securities, besides the 15-year fixed rate securities. All this helps to diversify its investment portfolio.
Diversification equals higher yields
Its expansion into residential loan securitization, (along with attractive opportunities in AAA residential mortgage backed securities), powered by new issue CMBS, should stabilize yields. Unfortunately, recent funding actions have resulted in a higher cost of funds. Fortunately, this provides a more stable funding source as it has a lower reliance on repo financing.
Through incremental investment income, as well as attractive AAA RMBS and CMBS opportunities, I’m confident it will be able to maintain its current dividend rate, despite management’s cautious outlook. You can also expect further upside from commercial real estate loans and investments in GSE risk sharing securities.
Key growth drivers
Invesco Mortgage Capital Inc (NYSE:IVR) has been able to contain some of the pressure on its asset yields through its non-MBS investments. Its expansion into non-MBS helps mitigate the ongoing agency yield compression. Agency yields are under tremendous pressure due to Fed’s ongoing Agency MBS purchases. In order, to keep the long-term mortgage rates low, the Fed has been buying Agency MBS, which resulted in a price hike. Since the price and the yield of a fixed income instrument are inversely proportional, the yields on these MBS fell.
Higher leverage levels will also help the company generate a higher return of equity in the coming future. Its total leverage of 6.4 times will allow the prepayment protected Agency securities and high-rated non-Agency investments more room to increase leverage. And that’s ok, because its leverage is still below historical levels.
Competition
But when you compare the two, Invesco Mortgage Capital Inc (NYSE:IVR) has a better shot at winning. And that’s because Invesco Mortgage Capital Inc (NYSE:IVR) has diversification in both its investment portfolio and the source of its funds. Further, Annaly Capital Management, Inc. (NYSE:NLY) is more leveraged than Invesco Mortgage leaving less room for it to increase leverage and magnify results.
In contrast, American Capital Agency Corp. (NASDAQ:AGNC) has positioned its portfolio for a declining interest rate environment. And that’s why it didn’t suffer as much as its competition when the Fed launched easing programs. With rising rates we could see a sharp decline in the company’s book value. American Capital Agency Corp. (NASDAQ:AGNC) is also a pure-play mortgage REIT that invests in fixed rate Agency residential mortgage backed securities.
If the Fed decides to exit the MBS markets, American Capital will be beaten by Invesco Mortgage Capital Inc (NYSE:IVR). And that’s because Invesco’s assets are more diversified, which supports its asset yield. Further, American Capital Agency Corp. (NASDAQ:AGNC)’s investments are positioned to benefit from a declining interest rate environment, which should not be the case if the Fed decides to leave well enough alone.
Conclusion
Invesco Mortgage Capital Inc (NYSE:IVR)’s increasingly diversified business model helps provide an offset to prevailing yield compression. Further, the prime jumbo tilt in the company’s non-Agency portfolio should benefit from an improving economy and loosening mortgage credit. Of the 3, Invesco Mortgage is the best bet.
Adnan Khan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Adnan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article This REIT Is Diversifying to Produce Stable Returns originally appeared on Fool.com is written by Adnan Khan.
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