Business context and reporting period
Chimera Investment Corporation’s Form 10-K covers the fiscal year ended December 31, 2016; fourth-quarter figures are identified where relevant. Chimera is an internally managed REIT investing on a leveraged basis in mortgage assets. Its objective is to generate long-term risk-adjusted returns, primarily through dividends. The filing reports that the company’s financial statements received an unqualified audit opinion and management concluded its disclosure controls and internal control over financial reporting were effective.
The portfolio shifted further toward residential mortgage credit: at year-end, securitized residential mortgage loans were 56% of interest-earning assets, Agency MBS 28%, and Non-Agency RMBS 16%, compared with 34%, 46%, and 20%, respectively, a year earlier.
Key financial metrics
| Metric | 2016 | 2015 |
|---|---|---|
| Interest income | $934.1 million | $872.7 million |
| Interest expense | $347.9 million | $259.4 million |
| Net interest income | $586.2 million | $613.4 million |
| GAAP net income | $551.9 million | $250.3 million |
| Net income per basic common share | $2.93 | $1.25 |
| Core earnings per basic common share (non-GAAP) | $2.42 | $2.37 |
| Economic net interest income (non-GAAP) | $557.2 million | $567.4 million |
| Economic net interest rate spread | 3.4% | 3.5% |
| Common dividends declared per share | $2.44 | $1.92 |
Fourth-quarter 2016 net income was $221.9 million, or $1.17 per common share; core earnings were $121.3 million, or $0.65 per share. The filing attributes full-year GAAP income growth largely to $218 million of higher net unrealized gains on financial instruments versus 2015 and a one-time $95 million recovery from other parties. Core earnings increased slightly per share, despite declining in total to $454.9 million from $472.4 million.
At December 31, 2016, total assets were $16.7 billion, total liabilities $13.6 billion, stockholders’ equity $3.12 billion, cash and cash equivalents $177.7 million, and book value per common share $15.87. Debt-to-equity leverage was 4.1:1, versus 4.0:1 a year earlier; recourse leverage declined to 1.8:1 from 2.5:1. Repurchase agreements totaled $5.60 billion and securitized debt totaled approximately $7.28 billion, including $6.94 billion of debt carried at fair value and collateralized by loans.
Operating activities provided $552.9 million of cash; investing activities used $1.27 billion; and financing activities provided $781.3 million. Cash increased $63.7 million during the year. The economic net interest margin was 3.8%, versus 3.9% in 2015. The filing does not present a conventional revenue or operating-margin measure; interest income and net interest income are the principal operating measures for this business.
Material changes versus the prior comparable period
- Chimera reduced Agency MBS exposure and expanded its residential credit portfolio. It acquired approximately $5.2 billion of seasoned residential subprime loans during 2016, primarily through securitization structures; year-end residential mortgage credit assets were approximately $12.1 billion, versus $8.4 billion in 2015.
- Interest income rose 7%, but interest expense rose 34%, contributing to lower net interest income and economic net interest income. Management cited higher financing costs, increased securitized debt and rising LIBOR.
- GAAP net income rose sharply, but included the one-time $95 million recovery and favorable fair-value movements. Core earnings, which exclude specified items, were $454.9 million, down from $472.4 million.
- Agency MBS at fair value declined to $4.17 billion from $6.51 billion; securitized loans held for investment at fair value increased to $8.75 billion from $4.77 billion.
- Chimera issued 5.8 million shares of 8.0% Series A cumulative redeemable preferred stock, raising $140 million net. It declared $1.94 per common share in regular dividends plus a $0.50 special dividend. No common shares were repurchased in 2016.
Outlook, commentary, risks and unusual items
Management described 2016 as a volatile interest-rate and credit-market year and said it would continue shifting asset allocation as market conditions change, with an emphasis on residential credit assets that it considers less rate-sensitive than Agency MBS. It stated that current assets, leverage and borrowing arrangements were expected to cover anticipated short-term liquidity needs, while cautioning that collateral-value declines could trigger margin calls or force asset sales. No specific earnings, dividend, or portfolio guidance was provided.
- Rates, spreads and hedging: Rising short-term rates can increase funding costs faster than asset yields adjust; hedges may be ineffective or costly. The company’s modeled Agency portfolio sensitivity to a parallel 100-basis-point rate increase was a 14.59% decline in annual net interest income and a 2.60% decline in portfolio value, including hedges. These are estimates, not forecasts.
- Leverage and liquidity: Repurchase funding is short-term and may be uncommitted; falling collateral values can prompt margin calls. Year-end repurchase agreements were spread across 25 counterparties. Weighted-average haircuts were 5.4% for Agency and 33.7% for Non-Agency collateral.
- Credit and valuation: Non-Agency RMBS and seasoned subprime loans bear borrower-credit, delinquency, foreclosure and loss-severity risk. At year-end, 91.1% of Non-Agency RMBS were rated below B or unrated. Significant assets and liabilities rely on Level 3 fair-value estimates; Level 3 represented approximately 74% of recurring-fair-value assets and 100% of recurring-fair-value liabilities.
- Concentration and structure: 51% of the Non-Agency RMBS portfolio was concentrated in California, Florida, New York and New Jersey. Consolidated securitization vehicles held $10.8 billion of assets and $7.3 billion of liabilities; those liabilities are generally non-recourse, but retained interests and required risk-retention positions absorb losses and may be illiquid.
- Unusual items and contingencies: The $95 million recovery related to remedies pursued concerning earlier Non-Agency RMBS accounting and financial-statement restatement matters; it was resolved in the first quarter of 2016 and treated as taxable income. The company reported no legal proceedings and management identified no contingency requiring accrual or disclosure at year-end, while noting repurchase obligations may arise from breaches of securitization representations and warranties.
- REIT and regulatory risks: Maintaining REIT status and exemption from the Investment Company Act constrains assets, income and distributions. Mortgage-market regulation, servicing practices, securitization rules and potential changes to Fannie Mae and Freddie Mac could affect asset availability, values and financing.
Most important facts for investors to verify
- How much of reported earnings and returns depended on the one-time $95 million recovery and unrealized fair-value changes, versus recurring core earnings and cash generation.
- Current delinquency, loss, prepayment and recovery trends in the expanding seasoned subprime loan portfolio, including the effect on securitized cash flows and retained risk.
- Whether the Level 3 loan and securities valuations remain supportable against independent pricing, realizable sale values and updated collateral performance.
- Funding availability, counterparty exposure, margin-call capacity and the impact of further rate increases on borrowing costs, hedges and dividend coverage.
- Taxable income and distribution requirements relative to GAAP and core earnings, and the sustainability of common and preferred dividends.