Chimera Investment Corporation — Q2 2015 Form 10-Q
Business context and period. This REIT invests primarily in Agency and Non-Agency residential mortgage-backed securities (RMBS) and securitized residential mortgage loans. The filing covers the quarter and six months ended June 30, 2015; financial figures below are in U.S. dollars unless stated otherwise. Per-share figures reflect the April 2015 1-for-5 reverse stock split.
Key financial results and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Interest income | $215.8m | $134.3m | $458.9m | $255.0m |
| Net interest income | $149.8m | $113.6m | $332.4m | $211.9m |
| Net income | $116.2m | $104.8m | $183.2m | $205.1m |
| Basic and diluted EPS | $0.57 | $0.51 | $0.89 | $1.00 |
- Q2 net income rose about 11% year over year, while six-month net income fell about 11%. Six-month results included $66.5m of net derivative losses, including $99.7m in swap-termination losses, and no repeat of the $47.8m VIE deconsolidation gain recorded in the first half of 2014.
- Interest income grew with acquisitions of seasoned sub-prime loans and a larger Agency portfolio. Higher financing costs accompanied the larger asset base. Q2 economic net interest spread was 3.6%, versus 4.9% a year earlier; net interest margin was 4.0%, versus 5.9%. Six-month spread and margin were 3.8% and 4.2%, respectively, versus 5.1% and 6.3%.
- At June 30, total assets were $15.75bn, liabilities $12.31bn, and stockholders’ equity $3.44bn, compared with $19.16bn, $15.55bn, and $3.61bn at year-end 2014. Cash and cash equivalents fell to $49.5m from $164.6m. The portfolio included $6.30bn of Agency RMBS, $3.94bn of Non-Agency RMBS, and $5.21bn of securitized loans held for investment.
- Total debt was approximately $11.70bn; total leverage was 3.4:1 versus 3.8:1 at year-end, and recourse leverage was 2.1:1 versus 2.6:1. Repurchase agreements were $6.81bn, with an average borrowing rate of 0.83% and an average remaining maturity of 88 days.
- For the six months, operating activities provided $192.3m, investing activities provided $1.75bn, and financing activities used $2.06bn. Cash decreased $115.1m. Dividends declared were $0.48 per share for Q2 and $0.96 for the first half.
Material changes versus comparable periods
- Portfolio mix shifted: at amortized cost, Agency MBS declined to 43.7% from 52.1% at year-end 2014, while Non-Agency RMBS increased to 10.1% from 5.1% and securitized loans to 35.4% from 32.5%.
- Six-month interest income increased 80% and net interest income increased 57%, but lower asset yields and greater financing costs narrowed the reported economic spread and margin. Six-month other comprehensive income was a loss of $141.9m, versus income of $88.8m in the prior-year period.
- Effective January 1, 2015, the Company adopted accounting guidance for qualifying consolidated collateralized financing entities and elected fair value accounting for certain loan assets and related debt. Adoption reduced equity by $12.1m. Fair-value changes on these instruments are recognized in earnings.
- The management fee rate had increased to 1.20% of gross stockholders’ equity in August 2014. The Company later terminated its external management agreement and became internally managed on August 5, 2015, after the reporting date.
Outlook, commentary, risks, and unusual items
- Outlook: The filing gives no specific earnings or dividend guidance. Management describes a strategy of adjusting asset allocation to market conditions and intends to pay regular quarterly dividends, subject to earnings, liquidity, debt service, and REIT requirements.
- Interest-rate and funding risks: The business depends on the spread between asset yields and financing costs. Rising rates may increase floating-rate funding costs faster than asset income; falling rates can increase prepayments and reduce income on premium assets. Repo financing also exposes the Company to renewal, haircut, collateral-value, and margin-call risks. Management’s Agency-portfolio sensitivity analysis estimated that a 100-basis-point rate increase would reduce portfolio value by 1.52% and raise annual economic net interest income by 9.66%; a 100-basis-point decrease would reduce that income by 28.84%. These are modeled estimates, not forecasts.
- Credit and valuation risks: Non-Agency RMBS are exposed to mortgage credit performance; 91.6% of the portfolio’s rated Non-Agency RMBS was below B or not rated. Six-month net other-than-temporary credit impairment losses were $34.9m, versus $6.9m a year earlier. The seasoned sub-prime loan portfolio reported $736.6m of principal in delinquency, bankruptcy, foreclosure, or REO categories; fair value of loans 90 or more days past due was $335m. Significant Level 3 valuations depend on management estimates of defaults, recoveries, prepayments, and discount rates.
- Unusual and subsequent events: The Company paid $100m to terminate interest-rate swaps with $1.2bn notional during the first half. Subsequent to quarter-end, it called $508m principal of securitized debt at par. On August 5, 2015, it agreed to repurchase 8,996,553 shares held by Annaly for $126m, expected to close around August 17. The manager termination did not require a termination fee; transition services were to continue through year-end, subject to possible extensions.
- Controls and contingencies: Management reported a previously identified material weakness involving spreadsheet reliance and manual calculations. A new system and controls were used for this quarter; management expected remediation during 2015, but the filing does not state that remediation was complete. The Company reported no contingency requiring accrual or disclosure at June 30, 2015. It also described prior derivative demands and continuing pursuit of remedies related to earlier accounting and restatement matters.
Important facts for investors to verify
- Whether the internalization, transition arrangements, and Annaly share repurchase were completed as planned, and their resulting costs and effects on shares and expenses.
- Subsequent-period liquidity, repo renewals, collateral haircuts, margin requirements, and exposure to counterparties, particularly given the reduced cash balance.
- Credit performance and fair-value assumptions for Non-Agency RMBS and seasoned sub-prime loans, including delinquency trends and impairment estimates.
- Whether net interest spread and margin stabilize as asset mix and financing costs change, and whether dividends remain supported by recurring earnings and cash flows.
- Whether management remediated the disclosed internal-control material weakness and whether any further legal or accounting developments arise.