Business context and reporting period
Chimera Investment Corporation is a leveraged mortgage REIT investing in residential mortgage loans, Agency mortgage-backed securities (MBS), and Non-Agency residential MBS. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2019; financial amounts below are rounded.
At quarter-end, the portfolio mix by amortized cost was approximately 49% residential loans, 44% Agency MBS, and 7% Non-Agency MBS. Management described the core portfolio as performing well and said it acquired loan pools during the quarter.
Financial performance and position
- Third-quarter earnings: Net income was $106 million, versus $157 million a year earlier. Income available to common shareholders was $88 million, or $0.47 per diluted share, compared with $147 million, or $0.79.
- Nine-month earnings: Net income was $283 million versus $514 million; income available to common shareholders was $229 million, or $1.22 per diluted share, versus $486 million, or $2.59.
- Net interest income: GAAP net interest income was $142 million in Q3, down from $147 million. For the first nine months it was $431 million, versus $440 million. Non-GAAP economic net interest income was $138 million for Q3 and $433 million for nine months, versus $148 million and $440 million, respectively.
- Spread and margin: Q3 economic net interest rate spread was 1.9%, down from 2.2%; economic net interest margin was 2.2%, down from 2.7%. Management attributed pressure to higher funding costs and a larger average financing balance.
- Other gains and losses: Q3 included $131 million of unrealized gains on financial instruments at fair value, offset by $137 million of net derivative losses. Nine-month totals were $522 million of fair-value gains and $578 million of derivative losses.
- Assets, debt, and equity: Total assets were $28.6 billion and stockholders’ equity was $4.0 billion. Repurchase agreements were $15.0 billion; securitized debt was $7.9 billion collateralized by loans and $139 million collateralized by Non-Agency MBS. Period-end GAAP leverage was 5.7:1, and recourse leverage was 3.8:1.
- Liquidity and cash flow: Cash and cash equivalents were $161 million, up from $47 million at year-end 2018. Operating activities used $145 million in the first nine months, compared with $490 million provided a year earlier; management cited $351 million of swap-termination payments and $106 million of derivative margin payments as key uses. Investing activities provided $211 million and financing activities provided $47 million.
- Book value and dividends: Book value per common share was $16.38, up from $16.24 at June 30, 2019. Common dividends declared were $0.50 per share for Q3 and $1.50 for the first nine months. The company issued $193 million net proceeds from Series D preferred stock in January.
Material changes versus comparable periods
- Common earnings fell materially year over year, principally because derivative losses increased; higher unrealized gains on financial instruments partly offset the effect.
- Economic spread and margin narrowed. For the nine months, interest income rose 10% to $1.02 billion, but interest expense increased 22% to $590 million.
- Management said the portfolio was repositioned toward Agency MBS. Agency MBS were 44% of portfolio amortized cost at September 30, versus 47% at year-end 2018; loans rose to 49% from 47%, and Non-Agency MBS to 6% from 5%.
- Period-end total leverage declined to 5.7:1 from 6.1:1 at year-end; recourse leverage remained 3.8:1.
- Non-Agency MBS fair value was $2.65 billion, versus $2.49 billion at year-end; Agency MBS fair value was $11.62 billion, versus $12.19 billion. Loans held for investment at fair value rose to $13.10 billion from $12.57 billion.
Outlook, management commentary, risks, and unusual items
- Management reported two Federal Reserve rate cuts in 2019 and noted falling medium- and long-term rates and an inverted yield curve. It cautioned that persistent inversion could constrain spreads through relatively high short-term funding costs and lower reinvestment yields.
- Lower mortgage rates accelerated refinancing and prepayments. Management also cited slowing home-price growth and historically low unemployment, which it viewed as supportive of housing.
- No specific earnings or dividend guidance was provided. Management said it seeks high-yielding investments while managing risk and intends to pay regular quarterly dividends, subject to operating needs, debt service, and REIT requirements.
- The company paid $148 million in Q3 and $351 million in the first nine months to terminate interest-rate swaps with respective notionals of $3.3 billion and $6.2 billion. These termination losses contributed to reported derivative losses and lower cash from operations.
- Repurchase agreements are short-term and collateralized; declines in collateral values can trigger margin calls or liquidity pressure. The filing reports $15.0 billion of repurchase agreements, with $10.2 billion maturing within 1–29 days. The company relies on renewals and may have to sell assets or raise capital if liquidity is insufficient.
- Interest-rate, basis, prepayment, extension, credit, and counterparty risks are significant. Management’s modeled sensitivity for Agency MBS and hedges estimated annual economic net interest income could rise 29.8% under a 100-basis-point rate decline or fall 28.7% under a 100-basis-point increase; these are model estimates, not forecasts.
- Credit indicators included 15.9% of residential loan unpaid principal balance delinquent or in bankruptcy, foreclosure, or REO, down from 16.8% at year-end. Non-Agency MBS were predominantly below B or unrated by the reported ratings mix. Fair-value estimates for loans and Non-Agency MBS rely substantially on management assumptions and Level 3 inputs.
- The company had commitments to acquire up to $752 million of residential loans, mostly expected to settle in Q4 subject to diligence and other conditions. It also had a $150 million commitment to Hains Point, of which $61 million was funded, and $732 million of unfunded construction-loan commitments. Subsequent to quarter-end, it exercised a call to retire $276 million of loan-backed securitized debt at par.
- Management was evaluating the expected impact of the credit-loss accounting standard effective January 1, 2020. The filing reported no legal proceedings and no material changes to the risk factors in the 2018 Form 10-K.
Important facts for investors to verify
- Whether the company’s net interest spread and margin can stabilize as the yield curve, funding costs, and mortgage prepayments change.
- How much of reported earnings volatility reflects derivative marks and swap terminations versus recurring net interest income; review the company’s non-GAAP economic earnings definitions and reconciliations.
- Liquidity under repo maturities, collateral haircuts, and potential margin calls, including the impact of planned loan purchases and unfunded commitments.
- Credit performance and fair-value assumptions for seasoned residential loans and predominantly lower-rated or unrated Non-Agency MBS.
- The sustainability of common and preferred dividends relative to future taxable income, financing costs, and REIT distribution requirements.