Chimera Investment Corporation — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019; the filing also reports fourth-quarter results. Chimera is a mortgage REIT investing mainly in residential mortgage loans and Agency and Non-Agency mortgage-backed securities. Its principal earnings source is net interest income, with leverage used to finance investments.
Financial performance and position
| Metric | 2019 | 2018 |
|---|---|---|
| Interest income | $1.361 billion | $1.273 billion |
| Interest expense | $758.8 million | $679.1 million |
| GAAP net interest income | $602.3 million | $594.2 million |
| Net income | $413.6 million | $411.6 million |
| Net income available to common shareholders | $340.8 million | $368.4 million |
| Basic earnings per common share | $1.82 | $1.97 |
| Common dividends declared per share | $2.00 | $2.00 |
| Total assets | $27.12 billion | $27.71 billion |
| Total stockholders’ equity | $3.95 billion | $3.70 billion |
| Book value per common share | $16.15 | $15.90 |
| Cash and cash equivalents at year-end | $109.9 million | $47.5 million |
Annual economic net interest income, a non-GAAP measure that includes realized swap settlements, was $597.4 million versus $593.5 million. The economic net interest spread narrowed to 2.0% from 2.2%, and net interest margin declined to 2.4% from 2.7%.
The cash flow statement reports $65.0 million provided by operating activities, $1.24 billion provided by investing activities, and $1.24 billion used in financing activities. Cash increased $62.4 million during the year. The MD&A narrative, however, describes operating activities as using approximately $65 million; this conflicts with the cash flow statement and warrants verification.
Year-end interest-bearing debt was approximately $21.7 billion; total debt-to-equity leverage was 5.5:1, down from 6.1:1, and recourse leverage was 3.4:1, down from 3.8:1. Repurchase agreements totaled $13.43 billion. Most Agency repo financing was short-term and renewable, exposing the company to refinancing, collateral and margin-call risk.
In fourth-quarter 2019, net income available to common shareholders was $111.9 million, or $0.60 per basic share. Net interest income was $171.5 million, compared with $141.6 million in the third quarter.
Material changes versus 2018
- Interest income rose 7%, but interest expense rose 12%; GAAP net interest income increased modestly.
- Common earnings fell to $340.8 million from $368.4 million, and basic EPS declined to $1.82 from $1.97. The filing attributes the decline mainly to higher preferred dividends and other expenses.
- Derivative losses increased to $500.4 million from $122.8 million, including $359.7 million of realized losses on terminated swaps. Chimera paid $360 million to terminate swaps with $6.4 billion notional value. These losses were partly offset by $409.6 million of unrealized gains on financial instruments at fair value.
- Portfolio mix shifted toward residential mortgage loans: loans were 55% of interest-earning assets at amortized cost versus 47% in 2018; Agency RMBS declined to 26% from 35%. Agency RMBS fair value fell to $6.49 billion from $9.24 billion, while loans held for investment rose to $14.29 billion from $12.57 billion.
- Year-end book value per common share increased to $16.15 from $15.90. Management linked the increase to lower interest rates, which raised asset values while reducing the value of hedges.
- Chimera issued $193 million net proceeds of Series D preferred stock in January 2019. Preferred dividends rose to $72.7 million from $43.2 million.
Outlook, risks and unusual items
Management said it would continue seeking high-yielding investments while managing risk, and described the core portfolio as performing well. It noted three Federal Reserve rate cuts in 2019, repo-market volatility beginning in September, and lower short-term rates that reduced fourth-quarter financing costs. Lower mortgage rates also accelerated prepayments. The company reported no specific earnings or balance-sheet guidance.
The board announced its intention to continue common dividends at $0.50 per share quarterly during 2020; this is not a commitment, and the board may reduce or eliminate dividends. Chimera declared $2.00 per common share for 2019.
- Leverage and short-term, largely uncommitted repo financing create exposure to rising funding costs, lender withdrawal, collateral haircuts and margin calls.
- Credit exposure includes seasoned and subprime residential loans, subordinate securitization interests and Non-Agency RMBS. At year-end, 91.6% of Non-Agency RMBS was rated below B or unrated; geographic exposure included California, Florida and New York.
- Valuation and earnings depend on management estimates of Level 3 assets. Level 3 represented about 64% of assets measured at fair value on a recurring basis, versus 55% in 2018. The auditor identified valuation of Level 3 instruments and interest-income estimates for Non-Agency RMBS and loans as critical audit matters.
- Interest-rate, prepayment, extension and basis risks may affect net interest income, asset values and hedging effectiveness. The filing’s sensitivity analysis estimates a 41.5% decline in annual net interest income under an immediate 100-basis-point rate increase, under stated assumptions.
- Other risks include securitization and servicing execution, LIBOR transition, regulatory and REIT qualification requirements, and potential limits on selling or hedging retained credit-risk interests.
- The filing reports no legal proceedings and no subsequent events. Ernst & Young issued an unqualified opinion on the financial statements and internal controls.
Important facts for investors to verify
- Reconcile the MD&A’s statement that operating cash flow was negative with the audited cash flow statement’s reported positive $65.0 million.
- Assess sustainability of common dividends against taxable income, cash generation, preferred dividend priority and financing needs; the stated 2020 dividend rate is only an intention.
- Review repo maturities, lender concentration, collateral haircuts, liquidity buffers and potential margin calls under stressed market conditions.
- Examine assumptions and sensitivity for Level 3 loan, Non-Agency RMBS and securitized-debt valuations, as well as expected credit losses and prepayments.
- Evaluate the effect of the $360 million swap termination loss, remaining hedge coverage and rate sensitivity on future funding costs and book value.