Chimera Investment Corporation — 2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014; includes fourth-quarter results. Chimera is an externally managed mortgage REIT investing in Agency and Non-Agency mortgage-backed securities (RMBS), securitized residential loans and related assets. The filing was signed March 2, 2015.
Financial and operating highlights
| Metric | 2014 | 2013 |
|---|---|---|
| Interest income | $687.8 million | $511.8 million |
| Interest expense | $147.8 million | $102.0 million |
| Net interest income | $540.0 million | $409.8 million |
| Net income | $589.2 million; $0.57 per basic share | $362.7 million; $0.35 per basic share |
| Core earnings (non-GAAP) | $402.0 million; $0.39 per basic share | $349.7 million; $0.34 per basic share |
| Operating cash flow | $182.8 million | $304.8 million |
| Cash and cash equivalents at year-end | $164.6 million | $77.6 million |
| Stockholders’ equity at year-end | $3.61 billion | $3.33 billion |
| GAAP book value per share | $3.51 | $3.24 |
Economic net interest income, a company-defined non-GAAP measure that includes realized swap costs, was approximately $487.5 million, versus $388.0 million in 2013. The economic net interest spread narrowed to 4.4% from 5.3%; net interest margin fell to 4.9% from 6.7%. Average asset yield declined to 6.9% from 8.8%, while average economic funding cost fell to 2.54% from 3.51%.
At year-end, total assets were $19.16 billion and total liabilities were $15.55 billion. Debt-to-equity was 3.8:1, up from 1.0:1; recourse leverage was 2.6:1. Repurchase agreements totaled $8.46 billion, versus $1.66 billion a year earlier. Management’s estimated economic book value was $3.18 per share, below GAAP book value of $3.51; the company cautions this non-GAAP estimate is judgmental and not a substitute for GAAP book value.
Cash flow reflected the sharp expansion of the portfolio: operating activities provided $182.8 million, investing activities used $5.78 billion, and financing activities provided $5.68 billion. Cash increased by $87.0 million during the year. Year-end repurchase agreements had a weighted-average remaining maturity of 100 days; they are short-term, uncommitted financing and expose the company to renewal and margin-call risk.
Fourth-quarter results and changes versus the prior period
Fourth-quarter 2014 net income was $6.5 million, or $0.01 per share, compared with $377.6 million, or $0.37 per share, in the third quarter. Fourth-quarter net interest income was $176.7 million. Results included $125.9 million of net derivative losses and $55.1 million of net other-than-temporary credit impairment losses; fair-value gains and realized sale gains partly offset these items. The exceptionally strong third-quarter result included a $47.8 million gain on deconsolidation and $162.9 million of fair-value gains on financial instruments.
For the full year, net income increased by $226.5 million from 2013, primarily as higher net interest income and fair-value gains outweighed derivative losses. The company reported $193.5 million of unrealized gains on financial instruments at fair value, $91.7 million of realized investment sale gains, a $47.8 million deconsolidation gain, and $186.3 million of net derivative losses. Net credit impairment losses were $64.0 million, up from $45.2 million in 2013.
The portfolio expanded and shifted toward Agency RMBS and securitized loans. The filing’s summary describes year-end 2014 holdings as approximately 52% Agency RMBS, 16% Non-Agency RMBS and 32% securitized residential loans, compared with 36%, 50% and 14%, respectively, in 2013. Another business-section presentation gives slightly different percentages; portfolio definitions and presentation should be checked against the financial statement notes. The company acquired approximately $12.1 billion of invested assets, sold $5.6 billion and received principal payments during 2014. It also acquired interests in trusts holding seasoned subprime loans, adding approximately $4.7 billion of loans and $4.0 billion of related secured debt to the consolidated balance sheet.
Common dividends were $0.09 per share in each 2014 quarter, or $0.36 for the year. A separate $0.20-per-share special dividend declared in 2013 was paid in January 2014. The 2013 annual dividend was $0.56 per share, including that special dividend.
Outlook, risks and unusual matters
- Outlook: Management provided no numerical earnings, spread, leverage or dividend guidance. It expects to adjust asset allocation with market conditions and anticipates continued use of repurchase agreements and securitizations, subject to availability and cost. Dividends remain at the board’s discretion.
- Interest-rate and funding exposure: Rising short-term rates can raise borrowing costs faster than income on fixed-rate assets. Falling rates can increase prepayments and impair interest-only securities. Repo financing is short-term, collateralized and subject to margin calls; a forced sale could crystallize losses. Hedging may not fully offset these risks.
- Credit, valuation and concentration: Non-Agency RMBS and seasoned subprime loans bear borrower credit risk. A substantial portion of Non-Agency RMBS was below B-rated or unrated, and the portfolio had geographic and vintage concentrations. Significant assets use Level 3, model-based fair values; approximately 49% of assets measured at fair value on a recurring basis were Level 3 at year-end.
- Reporting controls and filing history: Management concluded disclosure controls and internal control over financial reporting were ineffective at December 31, 2014 because of an unremediated material weakness involving reliance on spreadsheets with manual inputs and complex calculations. The auditor issued an adverse opinion on internal controls, while giving an unqualified opinion on the financial statements. Prior late SEC filings restricted access to Form S-3 and public capital markets; remediation efforts were ongoing, with a portfolio accounting system expected to become operational in 2015.
- Manager, legal and governance matters: The August 2014 amended management agreement raised the annual fee to 1.20% of gross stockholders’ equity and included an approximately $24 million manager payment related to derivative demand letters. The audit committee concluded its investigation in Q4 and reached an agreement with FIDAC; it was pursuing additional remedies against other parties. The manager is affiliated with Annaly, creating potential allocation and other conflicts; termination without cause may trigger a fee of twice the average annual management fee.
- Regulatory and tax status: Chimera reported that it qualified as a REIT and met its stated 1940 Act exemption tests at year-end. Failure to maintain either status could materially affect operations, leverage, taxes and distributions.
Investor verification priorities
- Reconcile the Q4 net income of $6.5 million with the large third-quarter result and identify the effects of derivatives, impairments, fair-value marks and deconsolidation.
- Review leverage, repo maturities, collateral haircuts, counterparty concentration, margin requirements and the company’s capacity to refinance or meet collateral calls.
- Assess the quality and valuation sensitivity of Non-Agency RMBS and seasoned subprime loans, including delinquency, default, loss severity and Level 3 assumptions.
- Track remediation of the spreadsheet-related material weakness and the consequences of the auditor’s adverse internal-control opinion and prior late filings.
- Evaluate dividend sustainability against REIT taxable income, cash generation, funding needs and the board’s discretion; do not infer taxable income directly from GAAP earnings.
- Review the amended management agreement, the related-party payment and ongoing legal matters, including potential additional costs or remedies.