CHIMERA INVESTMENT CORP quarterly report, Q3 FY2013

Chimera Investment Corporation — Form 10-Q Summary

Reporting period: Quarter and nine months ended September 30, 2013. The report was signed April 16, 2014. Amounts are in U.S. dollars; financial statement amounts below are in millions unless otherwise noted.

Business context

Chimera is an externally managed mortgage REIT investing primarily in residential mortgage-backed securities (RMBS) and securitized residential loans. Its portfolio is weighted toward credit-sensitive Non-Agency RMBS. FIDAC, a subsidiary of Annaly Capital Management, is the manager.

Financial results and condition

For the nine months, operating cash flow was $219.3 million, investing activities provided $296.4 million, and financing activities used $1,011.4 million. Cash declined by $495.7 million from year-end 2012. At September 30, repurchase agreements were $1,589.3 million, collateralized by Agency RMBS; their weighted-average borrowing rate was 0.42%, remaining maturity 58 days, and weighted-average haircut 4.76%. Consolidated VIE debt was $1,719.6 million and is non-recourse to Chimera, generally payable only from the respective VIE asset pools.

Management’s non-GAAP estimated economic book value was $3.01 per share, versus GAAP book value of $3.47; the stated difference was $477.1 million, primarily reflecting the treatment of assets and liabilities in consolidated securitization trusts. Management cautions that this estimate is judgmental and is not a substitute for GAAP book value.

Material changes and management commentary

• Quarterly net income fell $60.7 million year over year, chiefly alongside lower realized gains on investment sales and lower net interest income. Nine-month net income rose $41.3 million, as lower impairment losses and improved derivative results more than offset weaker net interest income.
• Nine-month net interest income declined $60.0 million to $303.2 million. The filing attributes this to lower average earning assets, including principal paydowns in consolidated VIEs. Management expected VIE interest income to continue declining as assets paid down, while proceeds were redeployed into the general portfolio and Agency RMBS.
• Economic net interest income, a management-defined non-GAAP measure including realized interest-rate hedge costs, was $98.3 million in Q3 2013 versus $105.0 million in Q3 2012. The reported economic net interest rate spread was 5.12% versus 4.90%; for the nine-month comparison, management said the spread declined 39 basis points.
• Q3 net other-than-temporary credit impairment losses were $16.5 million versus $10.0 million in Q3 2012; nine-month losses were $22.6 million versus $124.1 million in 2012. Management said it expected further, potentially volatile, impairment losses, particularly in subordinated Non-Agency RMBS.
• The portfolio shifted toward Non-Agency RMBS (79.1% of interest-earning asset principal at quarter-end, versus 74.6% at year-end 2012); securitized loans fell to 5.7% from 10.7%. Interest-only RMBS fair value rose to $336.4 million, but its net unrealized loss widened to $46.7 million from $4.8 million at year-end; fair-value changes on IO securities are recognized in earnings.
• Management reported that it had no plans, as of quarter-end, to increase RMBS or whole-loan assets through new consolidated VIE financing structures. It reported no new securitizations during the first nine months of 2013.

Outlook, risks, and unusual items

• The board declared regular dividends of $0.09 per share for Q4 2013 and Q1 2014 and indicated the same regular dividend for Q2 2014, subject to review. It also declared a $0.20-per-share special dividend paid January 31, 2014; that special dividend may be treated as return of capital for tax purposes.
• Interest-rate, prepayment, extension, basis, credit, market-value, real-estate, and counterparty risks are material. Management’s Agency RMBS sensitivity analysis projected annual economic net interest income changes from -17.07% under a 75-basis-point rate decline to +10.02% under a 75-basis-point rise; estimated portfolio value, including hedges, ranged from +1.73% to -2.70%, respectively. The filing cautions that actual outcomes could differ materially.
• Liquidity depends in part on short-term repo financing and collateral values. Margin calls or declining collateral values could require asset sales, potentially at a loss. Management believed available assets and borrowing arrangements were sufficient for anticipated short-term needs, but noted that delayed filings restricted access to Form S-3 and equity issuance until the company had been timely in its filings for a full year.
• Disclosure controls were deemed ineffective as of September 30, 2013, and material weaknesses in internal control over financial reporting were not fully remediated. The company described added accounting, middle-office, and reporting resources and independent pricing-service reviews, but stated remediation remained ongoing.
• The filing reports an ongoing Audit Committee investigation related to prior accounting and restatement matters, and three shareholder derivative demand letters alleging fiduciary-duty and disclosure failures. Management said no contingency requiring accrual or disclosure was identified at quarter-end; the investigation and potential actions could nonetheless adversely affect the company.
• The filing cover indicates the company had not filed all required reports during the preceding 12 months and had not submitted all required Interactive Data Files. The report also discusses prior restatements, late-filing consequences, and restrictions on issuing shares under its equity distribution and dividend reinvestment plans.

Important facts for investors to verify

• Whether subsequent filings resolved the reporting delinquency, restored eligibility to raise equity, and addressed the disclosed ineffective controls and material weaknesses.
• Current liquidity, repo counterparties, collateral haircuts and margin-call exposure, and the ability to refinance short-term borrowings.
• Performance and valuation assumptions for the large Non-Agency RMBS and IO portfolios, including defaults, loss severities, prepayments, and further impairment risk.
• Whether the stated dividend outlook was maintained, and the sustainability and tax characterization of regular and special distributions.
• Status and potential financial or governance effects of the Audit Committee investigation, derivative demands, and any related proceedings.
• Reconcile the MD&A’s Q3 investment-sale carrying-value figures, which differ from the amount reported in the financial-statement note; the filing text does not provide a clear reconciliation.