Chimera Investment Corporation — 2012 Form 10-K
Reporting period: Fiscal year ended December 31, 2012, with comparisons to 2011 and 2010. This filing was signed December 31, 2013 and states that the company was delinquent in SEC reporting. The summary below distinguishes year-end 2012 results from later developments disclosed in the filing.
Business context
Chimera is an externally managed mortgage REIT investing primarily in residential mortgage-backed securities (RMBS) and mortgage loans. Its objective is to generate risk-adjusted returns mainly through dividends. At year-end 2012, its interest-earning portfolio by principal value was 74.6% Non-Agency RMBS, 14.7% Agency RMBS and 10.7% securitized residential loans. Almost 97% of its Non-Agency RMBS was rated below B or unrated, making credit performance and valuation important risks.
Key financial results
| Metric | 2012 | 2011 |
|---|---|---|
| Interest income | $589.4 million | $705.0 million |
| Interest expense | $126.6 million | $134.9 million |
| Net interest income | $462.9 million | $570.2 million |
| Net income | $327.8 million | $137.3 million |
| Basic earnings per share | $0.32 | $0.13 |
| Dividends declared per share | $0.38 | $0.51 |
| Operating cash flow | $334.9 million | $447.7 million |
Annualized yield on average interest-earning assets fell to 5.50% from 6.16%. Economic cost of funds, including realized swap losses, rose to 3.36% from 2.52%, narrowing the net interest spread to 2.14% from 3.64%. Economic net interest income was $442.6 million versus $554.2 million.
Fourth-quarter 2012 net income was $78.7 million, or $0.08 per share, compared with $42.7 million, or $0.04 per share, in fourth-quarter 2011. Fourth-quarter net interest income was $99.7 million; economic net interest income was $94.3 million and the economic spread was 0.97%.
At December 31, 2012, total assets were $7.74 billion, liabilities $4.20 billion and stockholders’ equity $3.54 billion. Cash and cash equivalents were $621.2 million. Debt-to-equity was 1.1:1, down from 1.5:1; recourse leverage was 0.4:1 versus 0.9:1. Debt comprised $1.53 billion of repurchase agreements and $2.51 billion of securitized debt, which was non-recourse to Chimera. The filing’s estimated economic book value was $3.05 per share, compared with GAAP book value of $3.45, reflecting a $416.1 million adjustment related primarily to consolidated securitizations.
Investing activities provided $988.8 million of cash, while financing activities used $908.9 million; cash increased by $414.9 million during the year. The company received about $1.7 billion in principal payments across investment assets, sold $943.4 million of RMBS and purchased $1.5 billion of whole loans, which were securitized.
Material changes versus 2011
- Net income increased by $190.4 million, mainly because credit impairment charges declined and realized gains on investment sales increased. Chimera recorded $132.3 million of net credit-related other-than-temporary impairment (OTTI) losses in 2012, versus $357.1 million in 2011, and $85.2 million of realized investment-sale gains, versus $54.4 million.
- Net interest income and economic net interest income declined, reflecting lower average earning assets and a narrower spread. Average earning assets were $10.7 billion, down from $11.4 billion.
- Portfolio mix shifted: securitized loans rose to 10.7% from 3.5% of interest-earning assets, while Agency RMBS fell to 14.7% from 21.1%. Non-Agency RMBS remained the dominant allocation.
- Cash rose from $206.3 million to $621.2 million as the company reduced repurchase-agreement borrowings and increased securitized-loan financing. Repurchase agreements declined to $1.53 billion from $2.67 billion.
- Available-for-sale investments generated $556.5 million of other comprehensive income, compared with a $246.7 million loss in 2011. Total comprehensive income was $884.3 million versus a $109.3 million loss.
- Dividends declared fell to $0.38 per share from $0.51; $0.12 of 2012 dividends was characterized as return of capital for federal tax purposes.
Restatement, controls, outlook and risks
- Restatement: The company restated previously issued 2010 financial statements after identifying errors in applying accounting guidance to certain Non-Agency RMBS. The restatement reduced reported 2010 net income by $284.4 million, or $0.35 per diluted share; reduced net interest income by $173.6 million; and reduced retained earnings at December 31, 2010 by $409.9 million. The filing also describes corrections to certain prior-period OTTI and comprehensive-income presentations.
- Reporting and controls: Chimera said this 10-K was late and that its first three 2013 quarterly reports had not yet been filed. It was therefore unable to use its existing or a new Form S-3 shelf registration to raise public capital until it had been timely with filings for a full year. Management concluded disclosure controls and internal control over financial reporting were ineffective at December 31, 2012; Ernst & Young issued an adverse opinion on internal controls but an unqualified opinion on the 2012 financial statements. Remediation was underway, with additional accounting and review resources implemented during 2013.
- Legal and unusual items: An Audit Committee investigation into the accounting and restatement was ongoing. The company had received three shareholder derivative demand letters and could not predict their outcome. Under a March 2013 management-agreement amendment, FIDAC agreed to pay specified restatement, evaluation and investigation costs not covered by insurance; $4.7 million of expense recoveries was recorded in 2012.
- Management and related parties: The management fee was reduced from 1.50% to 0.75% of gross stockholders’ equity effective November 28, 2012, with the reduced rate to continue until SEC filings were current. FIDAC is an Annaly subsidiary; the filing identifies potential conflicts and related-party relationships.
- Outlook and distributions: No earnings or spread guidance is provided. Management expected the portfolio to remain weighted toward RMBS and described adjusting allocations with market conditions. The board declared $0.09 per share for each 2013 quarter and planned $0.09 regular quarterly dividends for the first two quarters of 2014, subject to review, plus a $0.20 special dividend payable January 31, 2014. Future distributions remain discretionary and depend on taxable income, liquidity, financing terms and other factors.
- Principal operating risks: Non-Agency mortgage credit losses, concentrated housing-market exposure, model-based fair-value estimates, interest-rate and prepayment mismatch, margin calls, short-term financing availability and counterparty risk. The company reported $1.36 billion notional of interest-rate swaps with a $53.9 million fair-value liability at year-end; swaps were not designated for hedge accounting. Its significant Level 3 Non-Agency RMBS valuations rely on unobservable assumptions.
Most important facts for investors to verify
- Whether the company subsequently filed all delinquent reports on time, restored Form S-3 eligibility and completed remediation of the material weaknesses.
- The restatement’s final effects and whether the accounting estimates for Non-Agency RMBS, OTTI and securitized loans remain supportable.
- Current liquidity, repurchase-agreement counterparties, margin-call capacity, recourse leverage and the sustainability of financing arrangements.
- Credit performance and valuation assumptions for the predominantly below-investment-grade or unrated Non-Agency RMBS portfolio, including geographic concentration and credit enhancement.
- Dividend coverage by REIT taxable income and cash generation, and the extent to which distributions include return of capital.
- The outcome and potential costs of the Audit Committee investigation and shareholder derivative demands, and whether FIDAC’s expense-reimbursement commitment fully covers eligible costs.