Business context and reporting period
Chimera Investment Corporation is an externally managed mortgage REIT investing primarily in residential mortgage-backed securities (RMBS) and residential mortgage loans. This Form 10-Q covers the quarter ended March 31, 2012; it was signed on June 21, 2013. The financial periods shown reflect a restatement of historical results.
Key financial metrics
Amounts below are in U.S. dollars; figures reported in thousands are converted to millions where indicated.
| Metric | Q1 2012 / March 31, 2012 | Comparable period / December 31, 2011 |
|---|---|---|
| Interest income | $149.7 million | $172.0 million, Q1 2011 |
| GAAP net interest income | $113.3 million | $136.5 million, Q1 2011 |
| Economic net interest income, including realized swap losses | $108.9 million | $133.6 million, Q1 2011 |
| Net income | $80.2 million | $100.6 million, Q1 2011 |
| Basic and diluted EPS | $0.08 | $0.10, Q1 2011 |
| Net interest spread | 3.26% | 3.42%, Q1 2011 |
| Return on average equity | 10.32% | 11.16%, Q1 2011 |
| Cash and cash equivalents | $131.3 million | $206.3 million, December 31, 2011 |
| Total assets | $8.25 billion | $7.75 billion, December 31, 2011 |
| Stockholders’ equity | $3.17 billion; GAAP book value $3.09 per share | $3.05 billion; GAAP book value $2.97 per share, December 31, 2011 |
| Total debt | $4.90 billion; debt-to-equity 1.5:1 | $4.52 billion; debt-to-equity 1.5:1, December 31, 2011 |
| Quarterly dividend declared | $0.11 per share | $0.14 per share, Q1 2011 |
Operating cash flow was $94.5 million, investing activities used $428.8 million, and financing activities provided $259.2 million. Cash declined by $75.0 million during the quarter. Repurchase agreements totaled $2.50 billion, with a weighted-average borrowing rate of 0.37% and remaining maturity of 49 days. Recourse leverage was 0.8:1; the company reported total leverage of 1.5:1.
Material changes versus the prior comparable period
- Net income fell $20.4 million year over year. Management attributed the decline mainly to lower net interest income and higher credit impairment charges, partly offset by greater realized gains on investment sales.
- Interest income declined $22.3 million, primarily as average interest-earning assets decreased from $11.2 billion to $9.7 billion. Portfolio yield edged up from 6.12% to 6.19%, but the average cost of funds rose from 2.70% to 2.93%.
- Net credit-related other-than-temporary impairment (OTTI) recognized in earnings increased to $48.4 million from $33.2 million. Total comprehensive income was $235.7 million, compared with $2.6 million in Q1 2011, principally reflecting a $155.5 million increase in other comprehensive income.
- The company purchased $753.7 million of jumbo-prime mortgage loans and securitized them, issuing senior bonds for $696.1 million of net proceeds and retaining subordinate tranches. Securitized loans held for investment increased to $983.6 million from $256.6 million at year-end.
- The RMBS portfolio’s fair value was $7.08 billion, versus $7.23 billion at year-end. Agency RMBS declined to $2.95 billion from $3.14 billion, while securitized loans became a larger portfolio component.
Outlook, risks, contingencies and unusual items
- Management expected the portfolio to remain weighted toward RMBS in the near term and anticipated continued reliance on repurchase agreements and investment cash flows for liquidity. It stated that current assets, leverage and borrowing arrangements were expected to cover short-term liquidity needs, while warning that falling collateral values could trigger margin calls and forced asset sales.
- The company disclosed no specific earnings guidance. It reported that the board determined regular dividends of $0.09 per share for each quarter of 2013; subsequent declared dividends were $0.09 per share for Q2 2012, Q3 2012, Q4 2012 and Q1 2013.
- Key exposures include Non-Agency RMBS credit risk, interest-rate and prepayment risk, valuation uncertainty, short-term repo refinancing and collateral margin calls, and counterparty risk. About 95.5% of the Non-Agency RMBS portfolio was rated below B or unrated. Non-Agency RMBS fair values rely on significant unobservable inputs.
- Interest-rate sensitivity analysis for the Agency RMBS portfolio projected net interest income down 3.72% under a 25-basis-point rate increase and down 11.61% under a 75-basis-point increase; these are model estimates, not forecasts of total company results.
- The company had restated prior financial statements after identifying materially misstated income and OTTI related to certain Non-Agency RMBS. A material weakness in internal control over financial reporting remained unremediated as of March 31, 2012, although the company hired a Chief Accounting Officer during March and reported subsequent improvements to review procedures.
- An Audit Committee investigation into the accounting and restatement was ongoing. The board had received four shareholder derivative demand letters; the company said it could not predict their outcome. Management reported no contingencies requiring accrual or disclosure, while certain securitization documents require repurchase of assets in specified circumstances following breaches of representations and warranties.
- Because of late SEC filings, the company said it could not use its existing shelf registration statements or issue shares under its equity distribution and dividend reinvestment plans until it had timely filed for a full year. The filing’s cover also marked “No” for having filed all required reports during the preceding 12 months.
- Later management-agreement amendments disclosed in the filing reduced the management fee from 1.50% to 0.75% effective November 28, 2012, until the company became current in its filings, and expanded termination rights. These events occurred after the reporting date.
Most important facts for investors to verify
- Review the restatement disclosures and the status and remediation of the material weakness, including whether later filings confirm effective controls.
- Assess the quality and sensitivity of Non-Agency RMBS valuations, expected cash flows and OTTI assumptions, given the large below-B-or-unrated exposure and Level 3 measurements.
- Verify the sustainability of earnings and dividends against lower economic net interest income, higher funding costs, impairment charges and subsequent dividend levels.
- Monitor repo funding availability, collateral haircuts, margin-call exposure, cash balances and the consequences of restricted access to equity markets.
- Check developments in the Audit Committee investigation, shareholder demands, SEC correspondence and any representation-and-warranty repurchase claims.