Chimera Investment Corporation — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017; selected fourth-quarter results are shown separately. Chimera is an internally managed mortgage REIT investing on a leveraged basis, principally in residential mortgage loans, Agency MBS and Non-Agency RMBS. Its stated objective is long-term risk-adjusted returns, primarily through dividends.
Financial and operating highlights
| Metric | 2017 | 2016 |
|---|---|---|
| Interest income | $1.139 billion | $934.1 million |
| Interest expense | $532.7 million | $347.9 million |
| GAAP net interest income | $606.0 million | $586.2 million |
| Economic net interest income (non-GAAP) | $589.5 million | $557.2 million |
| Net income | $524.7 million | $551.9 million |
| Net income available to common shareholders | $491.2 million; $2.62 basic EPS | $549.5 million; $2.93 basic EPS |
| Core earnings per basic common share (non-GAAP) | $2.34 | $2.42 |
| Operating cash flow | $487.3 million | $552.9 million |
| Common dividends declared per share | $2.00 | $2.44 |
At December 31, 2017, total assets were $21.2 billion, total liabilities $17.6 billion, and stockholders’ equity $3.63 billion. Book value per common share was $16.85, up from $15.87 a year earlier. Cash and cash equivalents were $63.6 million, down from $177.7 million.
Year-end debt-to-equity leverage, including repurchase agreements and securitized debt, was 4.6:1, versus 4.1:1 in 2016; recourse leverage was 2.0:1 versus 1.8:1. Debt included $7.25 billion of repurchase agreements and $9.39 billion of fair-value securitized debt collateralized by loans. Securitized VIE liabilities are non-recourse and payable only from the related collateral.
Economic net interest spread fell to 2.8% from 3.4%, and economic net interest margin to 3.3% from 3.8%. Average earning assets increased to $18.0 billion from $14.6 billion, while average interest-bearing liabilities rose to $15.5 billion from $12.7 billion. The average cost of funds, including realized swap costs, increased to 3.5% from 3.0%.
Fourth quarter: Net interest income was $157.8 million and net income was $107.6 million; common-shareholder income was $98.2 million, or $0.52 per basic share. Quarterly core earnings were $115.6 million, or $0.62 per basic share. The common dividend declared was $0.50 per share for each 2017 quarter.
Material changes versus 2016
- Portfolio growth shifted the mix toward residential mortgage loans: approximately 67% of interest-earning assets at amortized cost at year-end, versus 56% in 2016. Agency MBS declined to 22% from 28%, and Non-Agency RMBS to 11% from 16%.
- Loans held for investment grew to $13.7 billion from $8.8 billion. The company purchased $6.54 billion of loans in 2017 and reported $206.2 million of unrealized gains on loans measured at fair value.
- Interest income rose 22%, primarily from higher residential-loan balances. Interest expense increased 53%, reflecting higher debt balances and rates; management cited rising LIBOR and higher short-term rates.
- Common net income and core earnings per share declined. 2016 included a one-time $95 million receipt of additional remedies against other parties; 2017 also included $35.3 million of losses on extinguishment of debt and higher preferred dividends.
- Book value per common share increased, supported by residential credit market strength and fair-value gains. Total stockholders’ equity increased partly following the 2017 issuance of 13 million Series B preferred shares, which raised $314 million net.
Outlook, risks and unusual items
- Management provided no specific earnings, spread, portfolio-growth or dividend guidance. It said it would continue seeking high-yielding investments intended to support a durable dividend while managing risk and protecting book value; allocations may change with market conditions.
- The company purchased $6.5 billion in unpaid principal balance of residential mortgage loans during 2017 and retained $2.2 billion of risk-retention interests as sponsor. Retained subordinate interests bear early credit losses and are subject to restrictions on sale and hedging.
- Credit risk is material: much of the loan and Non-Agency RMBS exposure is seasoned, non-agency collateral, with subordinate holdings potentially absorbing first losses. The residential-loan portfolio had a weighted-average loan-to-value ratio of 88% and FICO score of 631; reported principal 90 or more days delinquent was $753 million, versus $549 million in 2016.
- Mortgage assets, funding and earnings are exposed to interest-rate, prepayment, extension, credit-spread, valuation and refinancing risks. Repurchase financing may be short-term, counterparties may demand additional collateral, and falling collateral values could trigger margin calls or forced sales. Hedging may not fully offset these exposures.
- Fair-value estimation is a significant source of uncertainty: Level 3 assets were approximately 79% of assets measured at fair value on a recurring basis, versus 74% in 2016. Valuations depend on management models and assumptions about defaults, prepayments, loss severity and discount rates.
- Management described 2017 hurricanes and California wildfires as not expected to have a significant financial-statement impact, while noting that future events affecting a larger share of assets could increase delinquencies and losses. Non-Agency RMBS exposure was concentrated in California, Florida, New York and New Jersey.
- The December 2017 Tax Cuts and Jobs Act changed corporate and individual tax rules, effective largely in 2018. Management noted uncertainty around some provisions, including possible earlier taxable-income recognition that could increase “phantom income” and liquidity needs to meet REIT distribution requirements.
- The filing reports no material legal proceedings and no subsequent events. The independent auditor issued an unqualified opinion on the financial statements and internal controls; management also concluded disclosure controls and internal control over financial reporting were effective.
Important facts for investors to verify
- Whether loan credit performance, delinquency trends and realized loss severities support management’s fair-value and cash-flow assumptions.
- How rising funding costs, asset yields, prepayments and hedges affect net interest spread, earnings and dividend coverage.
- The liquidity available to meet repurchase-agreement margin calls and near-term financing maturities, including the impact of the low year-end cash balance.
- The economic value and transferability of retained risk-retention interests, and the extent to which reported consolidated VIE assets and liabilities differ from Chimera’s recourse obligations.
- How much of the $2.00 common dividend is supported by taxable income and recurring cash generation; GAAP earnings, core earnings and REIT taxable income can differ materially.
- The assumptions and third-party pricing support underlying Level 3 valuations and the reported increase in book value.