Business context and reporting period
Chimera Investment Corporation is a leveraged mortgage REIT investing in residential mortgage loans, Agency mortgage-backed securities (MBS) and Non-Agency residential MBS (RMBS). This Form 10-Q covers the quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods unless noted. Amounts below are in U.S. dollars.
At quarter-end, the portfolio mix by amortized cost was approximately 52% residential mortgage loans, 41% Agency MBS and 7% Non-Agency RMBS, compared with 67%, 22% and 11%, respectively, at December 31, 2017.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Interest income | $321.7 million | $296.8 million | $925.3 million | $836.8 million |
| Interest expense | $174.7 million | $140.4 million | $485.2 million | $388.5 million |
| Net interest income | $147.0 million | $156.5 million | $440.1 million | $448.3 million |
| Net income | $157.3 million | $139.2 million | $514.4 million | $417.1 million |
| Net income available to common shareholders | $147.4 million | $129.8 million | $485.7 million | $393.0 million |
| Diluted earnings per common share | $0.79 | $0.69 | $2.59 | $2.09 |
| Common dividends declared per share | $0.50 | $0.50 | $1.50 | $1.50 |
Net interest income is the principal recurring income measure; earnings also included material derivative and fair-value changes. Q3 economic net interest income, a non-GAAP measure, was $147.6 million, with a 2.2% net interest rate spread and 2.7% net interest margin. The spread and margin were each 0.5 percentage points lower than in Q3 2017. Core earnings, also non-GAAP, were $111.8 million, or $0.60 per basic share, versus $116.3 million, or $0.62, a year earlier.
At September 30, 2018, total assets were $25.18 billion and stockholders’ equity was $3.91 billion. Cash and cash equivalents were $121.0 million. Repurchase agreements totaled $11.14 billion and securitized debt totaled approximately $8.99 billion. Reported GAAP leverage was 5.1:1, versus 4.6:1 at December 31, 2017; recourse leverage was 2.8:1 versus 2.0:1. Management reported book value of $17.02 per common share, slightly above $17.01 at June 30, 2018.
For the first nine months, operating activities provided $489.7 million of cash, investing activities used $3.72 billion and financing activities provided $3.29 billion. Cash increased by $57.5 million from year-end 2017. These cash flows reflect significant portfolio purchases, principal repayments, financing and dividends.
Material changes versus comparable periods
- Q3 common earnings rose by $17.5 million, principally because derivative gains increased by $72.7 million year over year; this was partly offset by a $53.3 million deterioration in unrealized results on financial instruments at fair value.
- Nine-month common earnings increased by $92.7 million. Higher derivative gains and gains on debt extinguishment were partly offset by increased unrealized losses on financial instruments at fair value.
- Q3 GAAP net interest income declined by $9.4 million, although interest income increased 8%; interest expense rose 25% as borrowing balances and rates increased. For nine months, interest income rose 11% while interest expense rose 25%.
- Interest-earning assets grew, especially Agency MBS: Agency holdings at fair value were $9.41 billion at quarter-end, versus $4.36 billion at December 31, 2017. Management said it added approximately $2.4 billion of Agency securities during Q3.
- Accumulated other comprehensive income declined from $796.9 million at year-end to $627.9 million, including a $169.0 million nine-month OCI loss, primarily reflecting unrealized losses on available-for-sale securities.
Outlook, management commentary and risks
The filing gives no quantified earnings or dividend guidance. Management said it seeks high-yielding investments that support a durable dividend while managing risk and protecting book value. It described Q3 as a rising-rate environment: the 10-year Treasury yield rose about 20 basis points during the quarter, and the Federal Reserve raised its target rate by 25 basis points in September. Management noted that higher rates increased financing costs, while gains on interest-rate hedges and securitized debt largely offset portfolio mark-to-market losses.
- Interest-rate and funding risk: Much of the financing is floating-rate and short-term, while asset repricing may lag. The company warns that rising rates can compress spreads and increase margin-call or refinancing risk. Its modeled sensitivity estimated annual economic net interest income would fall 16.77% under an instantaneous 100-basis-point rate increase; actual results may differ.
- Leverage and liquidity: Repurchase agreements increased to $11.14 billion, with most maturities within one year. Management believes cash and liquid Agency securities are adequate for anticipated needs, but a decline in collateral values could create liquidity shortfalls or require asset sales, potentially at a loss.
- Credit and valuation risk: Mortgage loans and Non-Agency RMBS have meaningful credit exposure. Approximately 15.8% of the residential loan unpaid principal balance was reported delinquent, in bankruptcy, foreclosure or REO at quarter-end. Significant portions of Non-Agency RMBS, loans and related securitized debt rely on Level 3 valuation inputs and management assumptions.
- Other commitments and events: Unfunded construction-loan commitments were $898 million, expected primarily to be paid within one year. Chimera also committed $150 million to Hains Point, subject to consent and approval of capital calls. In September, it issued $252 million net of Series C preferred stock, with a 7.75% initial dividend rate that converts to a LIBOR-based floating rate in 2025. Subsequent to quarter-end, it exercised an option to retire $273 million of loan-backed securitized debt at par.
- The company recorded $19.3 million of gains on debt extinguishment in the first nine months, including $9.3 million in Q3. Management said no material changes had occurred to the risk factors in its 2017 Form 10-K. It reported effective disclosure controls and no material change in internal control over financial reporting during Q3.
Important facts for investors to verify
- Whether derivative and fair-value gains that materially lifted GAAP earnings are recurring; compare GAAP earnings with economic net interest income and core earnings, both non-GAAP measures.
- How higher LIBOR, borrowing costs, leverage and short-term repurchase maturities affect future spreads, book value and liquidity.
- Credit performance of the loan portfolio, including delinquency and loss trends, and the assumptions supporting Level 3 valuations and impairment estimates.
- Funding and timing of the $898 million construction-loan commitments and the $150 million Hains Point commitment, and the related investment returns and risks.
- Dividend sustainability relative to taxable income, recurring earnings, financing costs and the senior claims of preferred stock.