CHIMERA INVESTMENT CORP quarterly report, Q2 FY2022

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Business context and reporting period

Chimera Investment Corporation is an internally managed mortgage REIT that invests primarily in residential mortgage loans, Non-Agency RMBS and Agency mortgage-backed securities. This Form 10-Q covers the quarter and six months ended June 30, 2022; comparisons are with the prior-year period unless otherwise noted. Amounts below are in U.S. dollars.

Financial performance and condition

  • Q2 earnings: Interest income was $195.4 million and interest expense was $78.5 million, producing net interest income of $116.9 million. A $239.2 million net unrealized loss on financial instruments at fair value contributed to a GAAP net loss of $161.3 million, or $179.8 million available to common shareholders ($0.76 per basic share). Q2 2021 net income was $163.3 million, with $144.9 million available to common shareholders ($0.63 per basic share).
  • First-half earnings: Net interest income was $254.6 million, down from $307.1 million. Net loss was $424.1 million, or $461.0 million available to common shareholders ($1.95 per basic share), versus net income of $320.9 million and common earnings of $284.0 million ($1.23 per share) in first-half 2021. First-half 2022 included $609.4 million in net unrealized fair-value losses.
  • Margins and distribution measure: Q2 economic net interest income, a non-GAAP measure, was $116.8 million, down from $137.7 million in Q1 2022. The net interest rate spread and net interest margin each fell 80 basis points quarter over quarter, to 2.9% and 3.3%, respectively. Earnings available for distribution, also non-GAAP, was $73.9 million, or $0.31 per adjusted diluted share, versus $93.7 million, or $0.39, in Q1.
  • Cash flow and liquidity: For the six months, operating activities provided $258.7 million, investing activities provided $169.2 million and financing activities used $655.2 million. Cash declined by $227.3 million to $158.5 million at June 30, 2022, from $385.7 million at year-end 2021. The company reported $1.9 billion of unused, uncommitted warehouse facilities.
  • Assets, debt and equity: Total assets were $14.0 billion and total liabilities $11.1 billion; stockholders’ equity was $3.0 billion, down from $3.7 billion at year-end 2021. Interest-bearing debt was approximately $10.9 billion, including $3.15 billion of secured financing agreements and $7.76 billion of securitized debt. GAAP leverage was 3.7:1 versus 3.0:1 at year-end; recourse leverage was 1.1:1 versus 0.9:1.
  • Portfolio and book value: Loans held for investment were $11.9 billion at fair value; the portfolio represented approximately 87% of interest-earning assets. Non-Agency RMBS were $1.32 billion and Agency MBS $529.1 million. Management reported book value per common share of $8.82 at June 30, down $1.33 from $10.15 at March 31.
  • Dividends and repurchases: Q2 common dividends declared were $0.33 per share; preferred dividends were $18.4 million. Chimera repurchased about 5.4 million common shares at an average $9.10 per share for $48.9 million, leaving $177 million authorized. No shares were issued under its $500 million at-the-market program during the period.

Material changes versus comparable periods

  • Q2 2022 net loss improved from Q1 2022’s $262.8 million, primarily because fair-value losses were lower ($239.2 million versus $370.2 million), although net interest income also declined and interest expense rose.
  • Compared with first-half 2021, first-half 2022 interest income fell 20% and net interest income declined $52.5 million. Management attributed the lower interest income mainly to reduced average interest-earning assets and lower yields. The swing to a first-half loss primarily reflected fair-value losses amid higher rates and wider credit spreads.
  • Market-value losses on assets were partly offset by fair-value gains on loan-backed securitized debt. For the first half, management reported $1.0 billion of unrealized losses on loans, $82 million on Non-Agency RMBS and $54 million on Agency MBS, partly offset by $521 million of gains on related securitized debt.
  • Average borrowing costs increased with higher rates; Q2 secured financing borrowing rates were higher than at year-end 2021 across the reported collateral categories. Recourse financing declined by $276 million during Q2, while period-end GAAP leverage increased, in part reflecting the lower equity base.

Outlook, commentary and risks

  • Management cited high inflation, rapid Federal Reserve rate increases, mortgage rates above 6%, widening credit spreads and weaker mortgage origination and securitization markets. It expects continued market challenges but believes its strategy of acquiring, financing and securitizing residential mortgage loans can generate positive risk-adjusted returns over the long term. The filing provides no specific earnings or dividend guidance.
  • During Q2, Chimera completed two securitizations totaling approximately $728 million, purchased and settled $201 million of seasoned reperforming residential loans and $120 million of business-purpose loans, and refinanced or extended certain secured facilities. It purchased a $1 billion-notional swaption, with a 3.26% strike rate and a May 2023 start, to partially hedge future borrowing costs.
  • Key risks include rising funding costs, spread widening, fair-value volatility, margin calls and refinancing or counterparty risk; mortgage prepayment, extension and credit risk; and uncertainty in loan and securities valuations. Most loans and Non-Agency RMBS were Level 3 fair-value measurements using significant estimates. At June 30, internal values for 18 securities were $29 million above third-party prices in aggregate, and a loan pool’s internal value was $41 million above its third-party price; management retained the higher values after review.
  • Management’s modeled parallel-rate sensitivity estimated that a 100-basis-point increase would reduce net interest income by 8.49% and market value by 7.15%; a 100-basis-point decrease would increase them by 10.12% and 7.86%, respectively. The filing cautions that actual results may differ materially, particularly for larger rate moves.
  • At June 30, the company said it was compliant with financing covenants and did not expect a breach within 12 months. Its repurchase program and financing facilities remain subject to market conditions. The company also disclosed a $75 million capital commitment to a fund, $12 million of unfunded construction-loan commitments, and potential obligations to repurchase securitized assets following breaches of representations and warranties.
  • The filing reported no material change to the risk factors in the 2021 Form 10-K, no legal proceedings, no subsequent events, and effective disclosure controls.

Important facts for investors to verify

  1. Whether asset valuations, particularly Level 3 loan and Non-Agency RMBS marks, and the related debt offsets reflect market conditions; review the disclosed third-party pricing differences.
  2. How faster rate increases, spread movements and refinancing conditions affect net interest income, book value, collateral values, margin requirements and access to financing.
  3. Whether the $158.5 million cash balance and available facilities are sufficient for maturities, collateral needs, dividends and investment commitments; note that warehouse capacity is uncommitted.
  4. Credit performance of residential loans and Non-Agency RMBS, including delinquencies, expected losses and the $4.9 million securities credit-loss allowance.
  5. Whether common dividends remain supportable: GAAP results were loss-making, while earnings available for distribution is a non-GAAP measure and is not a guarantee of dividends or a proxy for REIT taxable income.