CHIMERA INVESTMENT CORP quarterly report, Q2 FY2018

Chimera Investment Corporation — Q2 2018 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2018. Chimera is a leveraged mortgage REIT investing in residential mortgage loans, Agency MBS and Non-Agency RMBS. Unless otherwise noted, dollar amounts below are in U.S. dollars.

Financial performance and position

Metric	Q2 2018	Q2 2017	Six months 2018	Six months 2017
Net interest income	$145.2 million	$150.7 million	$293.0 million	$291.8 million
Net income	$118.1 million	$115.0 million	$357.1 million	$277.8 million
Net income available to common shareholders	$108.7 million	$105.6 million	$338.3 million	$263.1 million
Basic EPS	$0.58	$0.56	$1.81	$1.40
Common dividend declared per share	$0.50	$0.50	$1.00	$1.00

Economic net interest income, a non-GAAP measure, was $146.9 million in Q2 2018, essentially unchanged year over year. Economic net interest rate spread was 2.5%, versus 2.7%; net interest margin was 2.9%, versus 3.2%.
At June 30, total assets were $23.26 billion, liabilities $19.61 billion and stockholders’ equity $3.65 billion. Cash and cash equivalents were $90.7 million.
Portfolio assets included $13.25 billion of loans held for investment, $6.99 billion of Agency MBS and $2.59 billion of Non-Agency RMBS. Interest-bearing liabilities were $18.65 billion, including $9.13 billion of repurchase agreements and $9.52 billion of securitized debt.
Reported GAAP leverage was 5.1:1, up from 4.6:1 at year-end 2017; recourse leverage was 2.5:1, up from 2.0:1. Book value per common share was $17.01, down from $17.12 at March 30, 2018.
For the first six months, operating cash flow was $306.0 million, investing cash flow was negative $1.89 billion, and financing cash flow was positive $1.61 billion. Cash increased $27.1 million to $90.7 million.

Changes versus comparable periods

Q2 common earnings increased modestly year over year, while net interest income declined. Six-month common earnings rose to $338.3 million from $263.1 million.
Management attributed the six-month earnings increase mainly to stronger derivative results, a $10.1 million gain on debt extinguishment versus a $48.0 million loss in 2017, and lower credit impairment losses. These gains were partly offset by lower unrealized gains on financial instruments at fair value.
Q2 interest income increased 6% to $306.4 million, but interest expense rose 17% to $161.3 million, reflecting higher balances and rates. Average one-month and three-month LIBOR were 91 and 114 basis points higher, respectively, than a year earlier.
Portfolio mix shifted toward Agency MBS: based on amortized cost, Agency MBS rose to 32.7% from 22.2% at year-end, while loans fell to 58.8% from 67.3% and Non-Agency RMBS to 5.3% from 5.9%. The company added approximately $2.4 billion of Agency securities during Q2.
Six-month other comprehensive income was negative $125.3 million, reducing accumulated other comprehensive income from $796.9 million to $671.7 million.

Outlook, risks and notable items

Management provided no specific earnings or dividend guidance. It said it would continue seeking high-yielding investments while managing risk and safeguarding book value, and expects to maintain regular quarterly dividends subject to operating needs, debt service and REIT requirements.
Management described Q2 as a volatile rate environment: the Federal Reserve raised its target rate by 25 basis points in June and the yield curve flattened. Asset mark-to-market losses were largely offset by gains on interest-rate hedges; the reported interest-rate spread remained 2.5% quarter over quarter.
The company relies on short-term, collateralized repo financing. Repo borrowings increased to $9.13 billion from $7.25 billion at year-end; higher rates, refinancing availability, collateral haircuts and margin calls could pressure liquidity. Credit Suisse represented 11% of equity in repo-related exposure at quarter-end, with $410 million at risk as defined by the company.
Management’s rate sensitivity analysis for the Agency MBS portfolio and specified hedges projected annual economic net interest income down 6.02% and portfolio value down 0.61% for a 50-basis-point rate increase; for a 100-basis-point increase, the projected declines were 14.19% and 1.50%. These are model estimates, not forecasts of company-wide results.
Credit and valuation risks remain material: 15.5% of residential loan unpaid principal was delinquent 30 days or more or in bankruptcy, foreclosure or REO, versus 16.1% at year-end. Most Non-Agency RMBS was rated below B or unrated, and significant asset values depend on Level 3 models and unobservable assumptions.
Q2 included $24.5 million of net derivative gains, versus $21.8 million of losses a year earlier; much of the year-to-date benefit came from unrealized gains. Six-month debt extinguishment gains were $10.1 million. These items can make GAAP earnings volatile.
Unfunded construction-loan commitments were reported at $784 million, primarily payable within one year. The company also disclosed possible repurchase obligations for securitized assets if specified representations and warranties are breached. It reported no legal proceedings, no material changes to previously disclosed risk factors, and no subsequent events.

Important facts for investors to verify

Whether recurring net interest income and core earnings support the $0.50 quarterly common dividend, given rising funding costs and narrower spread and margin.
The sensitivity of reported earnings and book value to interest rates, hedge performance, prepayments and the company’s significant Level 3 fair-value assumptions.
Repo renewal, collateral and counterparty concentration risks, including the potential liquidity effects of adverse market-value movements or margin calls.
Loan and Non-Agency RMBS credit performance, delinquency trends, expected recoveries and the company’s assumptions for impairment and cash flows.
The timing and funding needs of the $784 million construction-loan commitments, as well as any material claims under securitization representations and warranties.