Chimera Investment Corporation — Q1 2014 Form 10-Q
Reporting period: Quarter ended March 31, 2014. Chimera is an externally managed mortgage REIT investing primarily in Agency and Non-Agency residential mortgage-backed securities (RMBS) and securitized residential loans. Comparisons below are with Q1 2013 unless otherwise noted; balance-sheet comparisons are with December 31, 2013. Dollar amounts are in millions unless specified.
Financial results and position
| Metric | Q1 2014 / March 31, 2014 | Comparable period / December 31, 2013 |
|---|---|---|
| Interest income | $120.7 | $125.8 |
| GAAP net interest income | $98.2 | $97.0 |
| Economic net interest income, management-defined non-GAAP | $91.9 | $91.4 |
| Net income | $100.4; $0.10 per diluted share | $79.8; $0.08 per diluted share |
| Comprehensive income | $131.0 | $203.6 |
| Operating cash flow | $64.0 | $66.4 |
| Investing cash flow | $435.7 | $468.9 |
| Financing cash flow | $(536.8) | $(507.0) |
| Cash and cash equivalents | $40.6 | $77.6 at December 31, 2013 |
| Total assets | $6,707.0 | $6,936.1 at December 31, 2013 |
| Stockholders’ equity | $3,370.2 | $3,331.5 at December 31, 2013 |
| Debt-to-equity leverage | 0.9:1; recourse leverage 0.5:1 | 1.0:1; recourse leverage 0.5:1 |
Management reported an economic net interest spread of 4.98% versus 4.99% and a net interest margin of 6.58% versus 6.23%. These are management-defined measures; economic interest expense includes realized losses on interest-rate hedges. Repurchase agreements were $1,561.9 million, at a weighted-average borrowing rate of 0.41% and 40-day weighted-average remaining maturity. Consolidated VIE securitized debt was non-recourse and backed by the respective VIE assets.
At quarter-end, the portfolio’s amortized-cost mix was 51.6% Non-Agency RMBS, 34.7% Agency RMBS and 13.6% securitized loans. The company reported $216 million of unpledged Agency RMBS as an additional liquidity source.
Material changes versus the prior comparable period
- Net income rose about 26%, primarily due to a $15.0 million unrealized gain on interest-only RMBS, lower net credit impairment losses ($1.5 million versus $6.2 million), and $8.4 million of realized investment-sale gains. These were partly offset by $7.9 million of derivative losses.
- GAAP net interest income was modestly higher, although interest income declined as average earning assets fell 5%. Economic net interest income was nearly flat; the economic spread was essentially unchanged.
- Cash declined by $37.0 million during the quarter. Investing cash inflows included $397.6 million from Agency RMBS sales and portfolio principal repayments; financing outflows included $297.9 million of dividends paid and net debt repayments.
- Total debt and reported leverage declined from year-end. Non-Agency RMBS rose to 51.6% of the portfolio’s amortized cost from 49.8%, while Agency RMBS declined to 34.7% from 36.1%.
- Other comprehensive income fell to $30.7 million from $123.8 million, contributing to lower comprehensive income despite higher net income.
Outlook, risks and unusual items
- Management expected to increase portfolio assets and leverage during the rest of 2014, mainly through repurchase agreements and purchases of Agency and Non-Agency RMBS. Subsequent to quarter-end, the company reported increasing its Agency portfolio by approximately $6 billion, financed primarily with repurchase agreements.
- The board determined quarterly dividends of $0.09 per share for each of Q2, Q3 and Q4 2014. The company stated that distributions remain subject to operating needs, debt service and REIT requirements.
- Interest-rate, prepayment, extension, credit, market-value and financing risks are material. Management cautioned that rising rates could increase borrowing costs, reduce asset values and narrow spreads; changing prepayments can affect yields, asset duration and hedge effectiveness. Its Agency-portfolio model projected a 3.14% decline in portfolio value for a 75-basis-point rate increase and a 3.92% increase in annual economic net interest income; management warned actual results could differ materially.
- Non-Agency RMBS carry substantial credit and valuation uncertainty: 93% of the portfolio’s reported credit ratings were below B or unrated, and $3.87 billion of recurring fair-value assets were Level 3. Fair values depend on significant estimates, including defaults, prepayments, loss severity and discount rates.
- The filing states that material weaknesses in internal control over financial reporting were not fully remediated and disclosure controls were ineffective as of March 31, 2014. The cover page also marks “No” for having filed all required reports during the preceding 12 months. The filing says late filings restrict access to Form S-3 until the company has timely filed for a full year.
- An Audit Committee investigation into prior Non-Agency RMBS accounting and a restatement remained ongoing. Three shareholder derivative demand letters were reported; the Audit Committee said it had reached an understanding with the manager addressing those demands and expected to consider further remedies against other parties.
- The company recorded a $2.2 million loss after purchasing $54 million principal amount of securitized debt for $56 million. It also reported a post-quarter VIE transaction in which it elected not to repurchase certain interests and expected to recognize a gain in Q2; the filing text does not provide a clear amount.
- The company reported no material litigation accruals or capital-expenditure commitments. The filing identified no material changes to the risk factors in its 2013 Form 10-K.
Investor verification priorities
- Confirm the status and timetable for timely SEC filings, remediation of the disclosed material weaknesses, and the effectiveness of disclosure controls.
- Review the quality and sensitivity of Level 3 Non-Agency RMBS valuations and the assumptions supporting expected cash flows, impairment and yields.
- Assess the consequences of the subsequent approximately $6 billion Agency portfolio increase for leverage, repo funding, liquidity, hedging and interest-rate exposure.
- Verify the VIE transaction’s Q2 accounting and expected gain, and evaluate the company’s remaining exposure to securitization and repurchase-agreement counterparties.
- Compare dividends with taxable income, recurring earnings and cash generation; Q1 declared dividends were $0.09 per share, while cash dividends paid were $297.9 million.