Chimera Investment Corporation — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. Chimera is a leveraged mortgage REIT investing in residential mortgage loans, Agency and Non-Agency mortgage-backed securities (MBS), and related assets. Its objective is to generate long-term risk-adjusted returns, primarily through dividends.
Key financial results and position
| Metric | 2018 | 2017 |
|---|---|---|
| Interest income | $1.273 billion | $1.139 billion |
| Interest expense | $679 million | $533 million |
| Net interest income (GAAP) | $594 million | $606 million |
| Net income | $412 million | $525 million |
| Net income available to common shareholders | $368 million; $1.97 per basic share | $491 million; $2.62 per basic share |
| Core earnings (non-GAAP) | $440 million; $2.35 per basic share | $440 million; $2.34 per basic share |
| Economic net interest income (non-GAAP) | $593 million | $589 million |
| Economic net interest rate spread / margin | 2.2% / 2.7% | 2.8% / 3.3% |
| Operating cash flow | $298 million | $487 million |
| Cash and cash equivalents at year-end | $47 million | $64 million |
| Total assets / total liabilities | $27.7 billion / $24.0 billion | $21.2 billion / $17.6 billion |
| Stockholders’ equity / book value per common share | $3.704 billion / $15.90 | $3.635 billion / $16.85 |
| Debt-to-equity leverage | 6.1:1; recourse leverage 3.8:1 | 4.6:1; recourse leverage 2.0:1 |
2018 quarterly results were uneven. In the fourth quarter, net income was a loss of $103 million and net income available to common shareholders was a loss of $117 million, or $0.63 per basic share. The quarter included $316 million of net derivative losses, partly offset by $85 million of fair-value gains on financial instruments.
Cash from operations was more than offset by $6.0 billion of cash used in investing activities; financing activities provided $5.7 billion. Year-end repurchase agreements were $14.0 billion and securitized debt was approximately $8.6 billion at fair value, in addition to $160 million of Non-Agency MBS securitized debt. The filing says management believes cash and liquid Agency MBS are sufficient for anticipated short-term needs, while warning collateral declines could cause margin calls or a temporary liquidity shortfall.
Material changes versus 2017
- Chimera shifted its portfolio substantially toward Agency MBS: Agency MBS rose to about 47% of interest-earning assets from 22%, while loans fell to about 47% from 67% and Non-Agency RMBS to about 6% from 11% (based on amortized cost).
- Interest-earning assets grew to an average $21.8 billion from $18.0 billion. Interest income increased 12%, but interest expense rose 27%, reflecting larger financing balances and higher rates. Average asset yield declined to 5.8% from 6.3%; economic cost of funds rose to 3.6% from 3.5%.
- Economic net interest income increased slightly, but spread and margin each narrowed by 60 basis points. GAAP net income available to common shareholders fell $123 million, primarily due to a $129 million adverse swing in net derivative results and lower fair-value gains.
- Year-end leverage increased, and book value per common share declined $0.95. Management attributed the book-value reduction in part to year-end interest-rate declines causing losses in its hedge portfolio.
- Cash from operations declined to $298 million from $487 million. The company issued $252 million net of Series C preferred stock and repurchased $15 million of common shares.
Outlook, risks and unusual items
- The Board stated its intention to continue regular common dividends of $0.50 per share per quarter in 2019. This is not a commitment; dividends remain subject to Board discretion, earnings, liquidity, financing and REIT requirements. The 2018 common dividend was $2.00 per share.
- Management expects to adjust asset allocation as interest-rate and credit conditions change and to seek income-producing investments while managing risk. No specific earnings or financial-performance guidance is provided.
- Management described 2018 as a rising-rate environment: the Federal Reserve raised its target rate four times, short-term rates increased about 100 basis points, and the yield curve flattened. The filing warns that short-term borrowing costs can rise faster than asset yields, reducing spreads and potentially earnings and distributions.
- Key exposures include leverage and short-term, generally uncommitted repo financing; margin calls and forced asset sales; interest-rate, prepayment, extension and basis risk; credit losses on loans and Non-Agency MBS; illiquid assets and model-based valuations; counterparty and third-party servicer risk; and changes to LIBOR and the GSEs’ roles. About 55% of recurring fair-value assets were Level 3 at year-end, involving significant unobservable inputs.
- Residential credit exposure includes seasoned loans with an average loan-to-value ratio of 87.5% and average FICO score of 629. The Non-Agency RMBS portfolio was 94% below-B or unrated by fair value and had significant California concentration. The company also reports first-loss exposure on retained securitization interests.
- Unfunded commitments included $1.1 billion of construction-loan commitments, primarily payable within one year, and a $150 million commitment to the Hains Point fund, of which $2 million had been funded at year-end. The company also disclosed representations-and-warranties repurchase obligations in certain securitizations; no specific loss amount is stated.
- After year-end, Chimera issued Series D preferred stock for $194 million net proceeds. The 8.00% preferred dividend is senior to common distributions. The 2018 Series C preferred issue generated $252 million net proceeds and carries a 7.75% fixed rate through September 2025, then a floating rate based on three-month LIBOR plus 4.743%.
- Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting. Management also concluded disclosure controls and internal controls were effective as of year-end. The filing reports no legal proceedings or unresolved SEC staff comments.
Important facts for investors to verify
- Whether the 2019 common dividend intention is supported by REIT taxable income, cash generation and funding availability, given that GAAP earnings, core earnings and taxable income can differ.
- How higher financing costs, leverage growth and any further rate or yield-curve changes affect economic spread, book value, and exposure to repo margin calls and refinancing.
- Whether the company’s Level 3 valuation assumptions, loan credit performance, delinquency trends and Non-Agency first-loss exposures remain consistent with realized cash flows and market values.
- The timing and funding needs for the $1.1 billion construction commitments and Hains Point commitment, and the terms and performance of the related investments.
- The effect of preferred dividends and senior claims on cash available for common shareholders, including the post-year-end Series D issuance.