Chimera Investment Corporation — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; balance-sheet figures are as of March 31, 2016, compared with December 31, 2015. Chimera is a leveraged mortgage REIT investing in Agency and Non-Agency mortgage-backed securities and securitized residential loans. It internalized management in August 2015.
Financial performance and position
| Metric | Q1 2016 / March 31, 2016 | Comparable period / prior year-end |
|---|---|---|
| Interest income | $201.2 million | $243.1 million in Q1 2015 |
| Net interest income (GAAP) | $138.2 million | $182.7 million in Q1 2015 |
| Net income | $83.1 million; $0.44 per diluted share | $67.0 million; $0.33 per diluted share in Q1 2015 |
| Comprehensive income | $151.6 million | $25.9 million in Q1 2015 |
| Economic net interest income (non-GAAP) | $126.5 million | $167.2 million in Q1 2015 |
| Net interest rate spread / margin | 3.4% / 3.6% | 4.0% / 4.4% in Q1 2015 |
| Core earnings (non-GAAP) | $109.5 million; $0.58 per basic share | $147.7 million; $0.72 per share in Q1 2015 |
| Cash and cash equivalents | $190.5 million | $114.1 million at December 31, 2015 |
| Total assets / stockholders’ equity | $15.31 billion / $2.91 billion | $15.34 billion / $2.95 billion at December 31, 2015 |
| Debt and leverage | $11.66 billion interest-bearing liabilities; GAAP leverage 4.0:1; recourse economic leverage 2.8:1 | GAAP leverage 4.0:1; recourse economic leverage 2.7:1 at December 31, 2015 |
Operating cash flow was $107.6 million, investing cash flow was $180.7 million, and financing cash flow was negative $211.9 million. Cash increased $76.4 million during the quarter. Operating cash flow included the $95 million recovery described below. The filing reports no separate operating margin measure.
Portfolio fair values included $6.66 billion of Agency MBS, $3.58 billion of Non-Agency RMBS, and $4.61 billion of securitized loans. Repurchase agreements were $7.55 billion; securitized debt was approximately $4.11 billion. Consolidated VIE assets and liabilities were $6.80 billion and $4.12 billion, respectively; those assets are restricted to settling the VIEs’ obligations and their debt is generally non-recourse.
Changes versus comparable periods
- Net income rose $16.1 million year over year, but included a one-time $95 million recovery. Excluding that recovery, reported core earnings fell to $109.5 million from $147.7 million.
- Interest income fell 17%, primarily reflecting lower average yields and balances in Agency MBS; interest expense increased 4%, including higher repo costs. Economic net interest income declined about $40 million and spread and margin compressed.
- Derivative losses increased to $136.5 million from $106.6 million, driven in part by unrealized losses. Other comprehensive income improved to $68.5 million from a $41.2 million loss, principally from unrealized gains on available-for-sale securities.
- Total assets and equity edged lower from year-end. Cash increased, while repurchase agreements rose to $7.55 billion from $7.44 billion. Agency MBS increased modestly in fair value; Non-Agency RMBS and securitized loans declined.
Outlook, risks, contingencies and unusual items
- Management outlook: No quantified earnings or dividend guidance is provided. Management says it will adjust asset allocation to changing rate and credit conditions, pursue risk-adjusted returns, and expects to fund liquidity needs primarily through portfolio cash flows, repos and securitizations. It believes current liquidity is adequate, while warning that collateral-value declines could trigger margin calls and force asset sales or new financing.
- Rates, funding and hedging: The portfolio is exposed to interest-rate, basis, prepayment and extension risk; repo financing is short term and generally LIBOR-linked. Management’s sensitivity analysis estimates that a 100-basis-point rate increase would raise annual economic net interest income 15.54% but reduce Agency portfolio value 1.97%; a 100-basis-point decrease would lower income 17.21% and raise portfolio value 0.62%. These are model estimates, not forecasts, and actual effects may differ materially.
- Credit and valuation: Non-Agency RMBS and seasoned subprime loans carry credit risk; 89.4% of the Non-Agency RMBS portfolio was rated below B or unrated. Significant assets and liabilities use Level 3 inputs, making valuations sensitive to assumptions about defaults, prepayments, severity and discount rates. Q1 credit impairment losses were $10.7 million, versus $7.8 million a year earlier.
- Liquidity and counterparties: Repo agreements totaled $7.55 billion, with a 74-day average maturity and $8.92 billion of pledged MBS collateral. The filing reports $401.4 million of exposure to seven European-domiciled or affiliated counterparties (2.63% of assets), and $314 million at risk with one repo counterparty. Swap collateral and counterparty performance are additional risks.
- Distributions and capital: Chimera declared a regular $0.48-per-share dividend and a special $0.50-per-share dividend, totaling about $184 million. The special distribution followed the $95 million recovery, which the company characterized as 2016 taxable income. The $350 million repurchase authorization was increased during the quarter; no shares were repurchased in Q1, and $100 million remained available.
- Unusual items and subsequent events: The $95 million recovery resolved additional remedies related to the company’s prior Non-Agency RMBS accounting and restatement matters. Chimera also recognized a $1.8 million loss extinguishing debt. After quarter-end, it agreed to acquire approximately $225 million of securities related to a company-sponsored seasoned-loan securitization and contributed $1 million to a subsidiary.
- Contingencies and controls: The company disclosed ordinary-course claims and potential repurchase obligations for breaches of securitization representations and warranties, but management reported no contingency requiring accrual or disclosure. Management said disclosure controls were effective and reported no material Q1 change in internal control over financial reporting. Risk factors were unchanged from the 2015 Form 10-K.
Key facts for investors to verify
- How much recurring earnings and dividend capacity remain after excluding the $95 million one-time recovery; compare GAAP earnings, core earnings and cash available for distributions.
- Whether asset yields, repo borrowing costs and hedge performance stabilize or further compress the 3.4% economic spread and 3.6% margin.
- Repo renewal terms, collateral haircuts, margin-call capacity and concentration of counterparty exposure, including the reported $314 million at risk with one counterparty.
- Performance of Non-Agency RMBS and seasoned subprime loans, including delinquencies, defaults, loss severities and the assumptions underlying Level 3 fair values and impairment estimates.
- How the planned $225 million securities acquisition is financed and affects leverage, liquidity and portfolio risk, and whether the remaining share-repurchase authorization is used.
- Whether Chimera continues to satisfy REIT distribution and asset tests and its exemption from Investment Company Act registration.